Emerging Markets Research J.P. Morgan Securities Inc.

August 5, 2005

Emerging Markets Today

In this issue
Mexico: Policy easing only in December. See page 8. Chile: Upside July CPI surprise testifies to economic strength and favors curve flatteners. See page 11. Corporate Spotlight: Dah Sing Bank, Singapore Telecommunications, and Chaoda Agriculture. See page 13.

Data releases today

JPM Forecasts US Jul Employment (000) Unemployment Rate (%) Workweek Average Hourly Earnings (%) 180 5.1 33.7 0.3

Market commentary
Emerging markets saw another positive session yesterday, a likely indication that the market is well prepared to digest an increase in US payrolls this morning (JPMorgan: 180K; unemployment rate: 5.1%). In general, the global backdrop and flows have remained supportive for emerging markets, in addition to the markets comfort (for now) with political developments in Brazil. Brazils spread tightened 2bp, but the real star continues to be the currency, which momentarily broke the USD/BRL 2.30 level. Alongside the BRL strength and higher than expected inflation data, the CLP rallied 1.5% after some some stop losses were triggered. We position for flattening of the CLP nominal curve via swaps (see Chile: Upside July CPI surprise testifies to economic strength and favors curve flatteners on page 7). The MXN lagged the rally in other Latam currencies and remained in a tight trading range. In Argentina, we note that USD Pars have underperformed USD Discount bonds by 25-30bp since early July. For investors who can trade GDP WI market, we recommend buying a GDP stripped USD Par and CDS; for investors who cannot, we recommend a cash neutral switch from USD Disc to USD Par (see Relative Value Commentary on the following page). Finally, as we went to press, Ecuadorean Finance Minister Correa had unexpectedly resigned his post. While in isolation the market may welcome this development given the uncertainty fostered by Correas heterodox rhetoric, this will once again shine the spotlight on the countrys ongoing precarious political situation. We do not anticipate any change to the prospective Venezuelan purchase of Ecuadorean debt. However, this question will certainly be first and foremost on the markets mind this morning after the past months substantial rally in Ecuadorian debt, and could cause some headline volatility.
Eric TorresAC

Brazil Jun Industrial Production (% m/m, sa) 1.7 Chile Jun Econ. Activity (IMACEC) (%oya) Czech Republic Jul CNB Minutes Hungary Jul Budget Balance (HUF bn) Jun IP prel. (%oya) India Aug WPI (%oya) Philippines Jul CPI (%oya) Taiwan Jul CPI (%oya) 960 6.5 4.1 3.7 1.8 6.2

EMBIGD, HY-ALL, HY-BB

Stripped spread
860 760 660 560 460 360 260 160 May 03 Sep 03 HY-BB Jan 04 May 04 Sep 04 Jan 05 May 05 HY-ALL Arg -rebalancing EMBIGD

Summary market table

Last
External Debt (bp) EMBIGD Spread EMBI+ Spread EMBIGD Brazil Brazil 40 EMBIGD Colombia EMBIGD Mexico UMS 15 EMBIGD Philippines EMBIGD Russia EMBIGD South Africa EMBIGD Turkey EMBIGD Venezuela JPM US HY (prev day) 271 281 382 476 304 162 120 418 131 87 261 416 357

Daily Weekly YTD

-2 -2 -2 -3 -4 0 -1 1 -2 -3 -4 -1 3 -14 -10 -23 -18 -17 -5 -3 -16 -15 -10 -17 -21 -6 -99 -76 6 18 -28 -11 -19 -39 -81 -14 -3 13 14 FX USD/ARS USD/BRL USD/COP USD/CLP USD/CKZ USD/HUF USD/KRW USD/MXN USD/PLN USD/RUB USD/TRY USD/ZAR Local Rates ARS Boden 12 (price) MXN 5Y TIIE IRS ZAR 5y swap rate

Last
2.860 2.302 2308 551 24.11 196.89 1,011 10.576 3.285 28.455 1.310 6.420

Daily Weekly YTD

0.0% 0.4% 0.0% 1.5% 0.6% 0.8% 0.6% 0.1% 0.8% 0.1% 0.7% 0.4% 0.1% 4.5% 0.1% 2.3% 3.6% 3.0% 1.7% 0.4% 2.5% 0.8% 0.7% 3.2% 4.0% 15.4% 2.8% 1.3% -7.4% -8.6% 2.4% 5.5% -9.0% -2.3% 2.7% -11.8%

Source: JPMorgan

Joyce Chang
(1-212) 834-4203 joyce.chang@jpmorgan.com

78.40 -0.6% 17.9% 9.2% 9.70 1 bp 7 bp -13bp 7.49 -6bp -19bp -33bp

www.morganmarkets.com

The certifying analyst(s) is indicated by the notation AC. See last page of the report for analyst certification and important legal and regulatory disclosures.

Emerging Markets Research Emerging Markets Today Frank Zheng AC (1-212) 834-4874 frank.zheng@jpmorgan.com

Relative value commentary

Argentina USD Par cheap to USD Discount and CDS
Argentina USD Pars have underperformed USD Disc by 25-30bp since early July The theoretical spread difference between Disc and Par is 148bp for the dollar price impact; at least 5070bp should be priced in instead of the current 25bp spread difference USD Par, without GDP warrants, has a negative basis of 60bp, while USD Disc still has a positive basis of 34bp For investors who can trade the GDP WI market, we recommend buying a GDP stripped USD Par and CDS For investors who can not trade the GDP WI market, we recommend to a cash neutral switch from USD Disc to USD Par to take advantage of Pars underpricing of GDP warrants In our model portfolio, we switch from Disc (plus Boden 12s amortization proceeds) to USD Par Argentinas GDP warrant price has moved up sharply since the beginning of July, from the market perception of 2 to the WI price of 4.5. We still hold the view that although our model price estimate is at 4.7, the market price should trade at a substantial discount (see the Relative Value section of the July 8 Emerging Market Outlook and Strategy). Argentina Disc spread has been flat since the beginning of July, with the GDP warrant revaluation from 2 to 4.5 canceling the higher US Treasury yields in July. However, the spread on the GDP warrant-stripped USD Par has widened by about 30bp during the same period, while comparables such as Boden 12s and Brazil 34s have tightened by 48bp and 18bp, respectively, since the beginning of July.

Chart 1: USD Par price has lagged behind USD Disc since July
100 98 96 94 92 90 88 86 84 82 Jun-16-05 38 37 36 35 34 33 Jun-30-05 USD Disc [Left]
Source: JPMorgan

Jul-14-05

Jul-28-05

USD Par [Right]

USD Par is very cheap to USD Disc against CDS curve

We estimate a theoretical spread difference between USD Disc and USD Par at 148bp, and believe a minimal spread difference of 50-70bp should be priced in. We generate this by extrapolating a default probability curve derived from the CDS curve and a fixed recovery rate of 25% of par. Because this fair spread is sensitive to the overall default probability (spread level), we believe a minimal spread difference of 50-70bp should be priced on the improving fundamentals (we have an overweight on Argentina, and expect the spread to become tighter over the time). In order to generate a sense of the relative pricing, we also calculate the adjusted basis of each bond versus the extrapolated CDS curve. On this adjusted basis, Pars are trading at a negative basis of -60bp while Disc are trading at +43bp. This negative basis is a rare phenomenon within emerging markets, especially when the raw basis of Brazil 34s and 27s is still at the 100bp range. However, we note that we are making an assumption about extrapolation of the CDS curve; hence the relevant point of comparison here is the relative level of the adjusted basis, not the absolute level. The impact of differential recovery rate should be ignored. There have been concerns regarding a difference in recovery value between Pars and Discounts, with an assumption of a lower recovery value on Pars. We believe that, over time, as the bonds change hands following the initial exchange, the anticipated recovery value will converge; hence any lower recovery value on Pars will not persist. In addition, Argentina has given equal treatment to the Brady bonds during the most recent restructuring.

August 5, 2005

Emerging Markets Research Emerging Markets Today Frank Zheng AC (1-212) 834-4874 frank.zheng@jpmorgan.com

At current prices, for USD Par to have similar basis to USD Disc, the breakeven recovery rate would be 15% on Par versus 25% on Disc. To test for this impact though, we have scaled the recovery value on Pars from 15% currently, rising to 25% over the next five years (flat to Discounts). This makes only a marginal difference, decreasing the fair value by just 0.67 points. However, this would also be offset by a lower recovery value assumption over the coming five years for CDS, as the Pars would be the cheapest to deliver. At current CDS spread levels, a lower initial recovery value would generate a lower probability of default, hence reducing significantly the impact of this change. Consequently, we believe that this phenomenon can be largely ignored.

Relative value views on other Argentina bonds

We continue to view Boden 12s as the cheapest bond on spread terms for investors with concerns about the US Treasury outlook. However, the cheapness of USD Par, after stripping GDP warrants at 4.5, is more appealing for the medium term investors from a total return perspective. Currently, EUR Par is trading at about 60bp wide to USD Par, and cheaper than USD Par on the theoretical basis. However, the possibility of more supply of EUR Par out of European investors and the lower market value on EUR GDP warrant make us prefer USD Par for now. However, we believe EUR Par is an attractive holding for long term investors on the spread basis. We recommend two trades to take advantage of USD Pars cheapness: 1. Buy 10-million Par and 4 million 10-year CDS, then sell 10 million GDP warrants and 7.2 million 10-year Treasury to hedge the interest rate risk. Although this trade has a net long DV01 of US$3,000 per bp, it is default hedged until the Par reaches the price level of 55. We prefer the 10-year CDS over the 5-year CDS as the curve rolldown is less in the 10-year sector than in the 5-year sector, and also a view that default is not a near term concern. This trade has a small negative carry of 83,000 per 3 months, but the income from GDP warrants should compensate for this. 2. Cash neutral switch from USD Disc to Par (28MM Par x 10MM Disc) for investors cant sell GDP in the WI market. We prefer a cash neutral switch over a DV01 switch, on the possible sticky price from low price Par and to reduce the mismatch on the GDP warrant. At the cash neutral switch, investors will only have a marginal short on GDP warrants of -1.7 million per 10 million Disc. Although this trade also has a DV01 long of US$3,000 per bp, it has a negative carry of 12,000 per 3-months and is long both convexity and default exposure. There are two risks in this trade: the repo squeeze on Disc and the possibility of stickiness in the price of Pars from its lower dollar price. Therefore, we prefer a DV01 long position and term repo on Disc. Within our model portfolio, we sell 2.016 million USD Disc at 97.5, and buy 10 million USD Par at 36.75. We maintain our 1.1% overweight on Argentina.

Estimate total return on a 5-year horizon

Our total return estimation also shows USD Par may produce a higher return over a 5-year horizon under different scenarios after stripping the GDP warrant at 4.5 points. We also performed three scenario analyses, in addition to the above static computation. The three scenarios we listed for Argentina five years forward are: 1. Bullish case: in which Argentina to become investment grade in five years, and Argentina CDS will have the current Mexico CDS spread level. 2. No change: effectively, Argentina CDS spread will stay at the current levels. 3. Bearish case, in which Argentina CDS spread will end up at levels back to January 2001, one year before default. We compute the total returns from the current GDP stripped prices, the five-year forward bond price, discounting the cashflow via CDS default probability and the coupon income during the next four years. In this exercise, we implicitly assume the basis will remain the same between USD Par and Disc in five years, so some of the Pars outperformance comes from the basis convergence. Still, as the following table shows, USD Par should outperform USD Disc in all three scenarios, after stripping the GDP warrant at 4.5 points.
Table 1: USD Par outperforms Disc under different scenarios over 5-year period
Bullish 109% 94% No Change 53% 43% USD Par USD Disc

Bearish 38% 23%

August 5, 2005

Emerging Markets Research Emerging Markets Today Ben Ramsey (1-212) 834-4308 benjamin.h.ramsey@jpmorgan.com

Brazil The new testimony of Roberto Jefferson before the Mensalao CPI failed to bring any new information on the scandals. Actually, the deputy centered his attack on the exChief of Staff Jose Dirceu, while shielding President Lula. Separately, the industrial activity figures released yesterday are depicting a resumption in economic expansion at the end of last quarter, helping to explain Lulas resilient approval ratings in the middle of the worst political crisis of recent Brazilian history. In fact, the June CNI survey printed industrial sales increasing 1.53% in the m/m (sa) comparison, while the operating rates increased to 82.6% from 81.9% in May. Watch today the June IP, which is expected to post a 1.7% surge (m/m sa), following the already significant expansion in May (1.25%). If our estimate is on the mark the perception of a reaccelerating industrial activity will be strengthened, reinforcing the odds of the COPOM staying on hold in August, despite the significant reduction in inflationary risks of late. Local market comment: Another positive session for the BRL, though there was no particular event driving the action. Actually, the political noise continues to provide some respite, as the probe so far has been limited to congress and kept away from the presidency. The followthrough from strong FX inflows pushed the BRL higher, to levels below USD/BRL 2.30 during the session. The currency closed at USD/BRL 2.305, or 0.26% higher. The DI curve closed slightly higher, as the CNI survey pointed to a firm industrial activity. For today the focus will be on the highly anticipated June IP figures locally, and the US labor report.
Felipe PianettiAC

Ecuador: Disentangling the financing puzzle Addendum After correcting a calculation error, the main findings of our recent research piece outlining a plausible muddle through scenario for Ecuador are unchangedin fact, the financing numbers look even better. Table 5 of our research report, Ecuador: Disentangling the financing puzzle (Emerging Markets Today, August 3) had a calculation error in the summation of the identified financing sources, which actually overestimated the governments financing gap. After making the correction, the resulting financing gaps are US$322 million in 2005 and US$281 million in 2006significantly below the previously estimated US$586 million and US$406 million, respectively (see the corrected table 5 below).
Table 5: Financing scenario for 2005-2006
US$ million
Borrowing requirements Central government balance External amortizations Domestic amortizations o/w CETES Clearance of arrears Identified financing sources Change in public sector deposits Domestic debt issuance o/w CETES FEIREP buybacks Project-related multilateral loans Exceptional financing IADB World Bank CAF Unidentified financing
Source: Ministry of Finance and JPMorgan

2005
2,580 71 948 1,561 1,326 0 2,257 -83 1,677 1,436 264 299 100 0 0 100 322

2006
1,857 68 882 979 525 -72 1,576 44 972 792 125 335 100 0 0 100 281

Ecuador As we went to press, Finance Minister Rafael Correa had unexpectedly resigned his post. Although Correa gave no reasons for his resignation, there was local talk that it came on the back of disagreements with President Palacio regarding the removal of Carlos Pareja as president of Petroecuador (Pareja was close to Correa), and possibly even the defiant response of Correa to the World Bank following its decision last week not to disburse the US$100 million loan that had already been approved in March. While in isolation the market may welcome this development given the uncertainty fostered by Correas heterodox rhetoric, this will once again shine the spotlight on the countrys ongoing precarious political situation. We do not anticipate any change to the prospective Continued on page 5
4

Under the lower financing gap estimates, the government would not necessarily have to increase the 50% limit on public debt holdings of the IESS. Among the three potential sources to reduce and/or cover the financing gap that we had identified in the report, the increase in the IESS capacity to buy government securities (from 50% to 60% of assets) would deliver an additional US$250 million of financing. This assumption is perhaps the most difficult one to materialize given the likelihood of stiff resistance from politically relevant pensioners. The lower financing gap estimates suggest the government could do without resorting to such a measure in 2005 if the oil windfall is higher and a budget under-execution of at least 5% occurs. For 2006, the US$300 million of so-called Chavez bonds would still be required to cover the gap (which is now almost a done deal since the Venezuelan foreign minister, Ali Rodriguez, confirmed the purchase of Ecuadorean bonds on Wednesday). The corrected version of the report can be found on www.MorganMarkets.com.
Luis OganesAC/Andres Ortiz August 5, 2005

Emerging Markets Research Emerging Markets Today Ben Ramsey (1-212) 834-4308 benjamin.h.ramsey@jpmorgan.com

Venezuelan purchase of Ecuadorean debt, as details of this operation seem to be nearing the final stages, and Correa had already removed himself from the technical discussion. However, this question will certainly be first and foremost on the markets mind this morning after the substantial rally in Ecuadorian debt and could cause some headline volatility.
Luis OganesAC/Ben Ramsey

not expect inflation pressures to build up (our year-end forecast if 5.0%oya is in line with the yearly target set by the BanRep).
Luis OganesAC/Andres Ortiz

Mexico Local market comment: As expected, rates and FX were rangebound yesterday ahead of the US payroll report today. The peso traded in another tight USD/MXN 10.575-10.625 range, failing to strengthen further despite a rally in the BRL. Certainly, the break through the 10.60 level has not been easy for the MXN. We maintain our view that although carry continues to be supportive (we do not rule the MXN testing the mid- 10.50s), further upside seems limited from current levels and we expect a correction over a three-month horizon. In fixed income, client activity in IRS remained thin and rates closed 1-2bp higher (4bp in the 7-year tenor) following the dynamics of the Bono market, which saw some profit-taking with a slightly steeper curve after the mini-rally seen during the past week. Bono rates increased around 6bp on average, driven apparently by profit taking in the July 11 Bono.
Eric TorresAC

Turkey The EC said yesterday that it had written to Turkey complaining that its legislation on religious foundations did not meet EU standards for the rights of religious minorities. According to the ECs spokesperson, Turkish authorities are aware of the importance of the issue and have vowed to address it once parliament resumes its activities in October. The spokesman also said that this would not threaten the start of the accession talks on October 3. Religious freedom is just one item of the long to-do list Turkey will be facing during accession talks. Given the rise of anti-enlargement rhetoric in Europe, Turkey will not enjoy the tolerance received by previous accession candidates and this should result in a lengthy negotiation process. However, the market is focused on the start of entry talks and if talks start on October 3, we expect to see a relief rally.
Yarkin CebeciAC

Colombia President Uribe met yesterday on an official visit with President Bush at the latters ranch in Crawford, Texas. The summit between both governments (the second in the year) aimed to strengthen bilateral relations and discuss terrorism and drug trafficking related issues. Importantly, President Bush reaffirmed his commitment to helping Colombia and noted he would request the US Congress maintain the Plan Colombia military assistance and financial aid package, which expires at the end of this year. Separately, central bank governor, Jose Dario Uribe confirmed that the BanRep will continue its intervention in the FX market if the peso continues to appreciate ahead of the inflows from the M&A transaction of local brewer Bavariawhich could reach US$1.4 billion, but are expected to enter the economy gradually in the coming months. Despite this announcement we continue to expect the COP to maintain its appreciation bias in the near term and remain between USD/COP 2305-2330. Although the heavy intervention in the FX market--which has not been fully sterilized by the monetary authority--will keep liquidity levels high, we do

Russia Economy Minister Gref said that Russia should reduce the tax burden on the oil sector before the end of 2005 in order to revive oil production and support economic growth. Growth in oil output production slowed to 2.7%oya in the first half of 2005 after a gain of 8.7%oya in 2004. Gref said that in September he would submit a proposal to cut export duties on fuel and suggest ways to encourage investment into the sector. Upward revisions to our GDP growth forecasts (currently 5.6% for 2005) will depend on the scope of the changes introduced. So far it remains unclear whether the government is willing to support a considerable decrease in oil sector taxation. Separately, Gref indicated that July CPI inflation slowed down to 12.8%oya from 13.3% in June. JPMorgan expects inflation to slow to 12.2%oya by the end of 2005 versus the upwardly revised official forecast of 11%.
Julia Ovanessian AC

CEEMEA FX EUR/USD remains the main focus with relative growth expectations dragging the cross higher. We expect this to continue today, with attention centered on the US payrolls release. CEEMEA currencies generally showed rather less dynamism yesterday as anticipation of the payrolls report made further inroads into thin summer trading volumes.

August 5, 2005

Emerging Markets Research Emerging Markets Today Ben Ramsey (1-212) 834-4308 benjamin.h.ramsey@jpmorgan.com

USD/ZAR and USD/TRY lagged the broader dollar weakness, suggesting that the local currency outperformance may be petering out as we approach 6.40 and 1.30, respectively, but our medium-term call for a renewed downturn in EUR/USD warrants keeping short EUR/ZAR positions for now, and continuing to weight a long TRY basket towards EUR (2/3) rather than USD (1/3). Aside from the US data releases, watch today for preliminary Hungarian IP in June at 8:00am London time. JPMorgan is looking for 6.5%oya growth, on a working-day adjusted basis, representing a slowdown after the May surge. The June PMI dropped below the 50 level in June after rising for three consecutive months. Watch also for South African reserves data for the end of July. We believe that the SARB continued to build reserve levels over the month, adding around US$1.5 billion, taking advantage of FDI and portfolio-related inflows.
Graham StockAC

China: further relaxations on forex control regarding current account convertibility The State Administration of Foreign Exchange (SAFE) has announced further moves to relax FX controls; this time they relate to corporate and individuals transactions under the balance of payments and current account. Effective August 2, the ceiling on the amount of foreign currency earnings that domestic corporates may retain under their individual FX accounts has been raised: to 50% (previously 30%) for corporates whose current account FX expenditure has been less than 80% of their current account FX and up to 80% (previously 50%) for corporates whose current account fx expenditure has exceeded 80%. The move is aimed at giving domestic corporates greater flexibility in mobilizing current account-related capital and should also help to lower currency conversion transaction costs, provide more room for corporates to retain FX earnings, better reflect the underlying supply and demand for local currency in the FX market, and further support reforms to allow the renminbi exchange rate formation mechanism to be determined by fundamental market forces. Effective August 3, Chinese residents departing the country for less than six months are now allowed to purchase foreign currencies with value equivalent to US$5,000 (previously US$3,000) while those departing for more than six months may purchase up to US$8,000 (previously US$5,000). The move is seen to be aimed at further facilitating current account transactions by individual Chinese residents, with outbound tourism likely being the main beneficiary. Overall, the recent measures by the authorities to facilitate balance of payments and current account outflows are not only targeted at containing the rapid accumulation in official FX reserves, but also supporting the governments consistent efforts to reform its currency regime and allow fundamental market forces to play a larger role in determining the countrys exchange rate. We continue to look for a total appreciation of the RMB against the USD for 7% by the end of 2005, and for a cumulative 15% by the end of 2006.
Grace NgAC

Asia FX The ADXY index flat-lined while regional currencies traded in mixed fashion yesterday. The majority of Asian currencies posted gains during early session; however, profit taking and short-coverings ahead of the US non-farm payrolls today dragged down Asian FX in later trading. Among the gainers, the KRW ignored net foreign equities outflow and the weaker KOSPI index to close at a six-week high against the USD. The relentless descent in spot is signaling BoKs discomfort as KRW presses closer to the key 1000 level. TWD also gained after yet another impressive foreign buying of local equities. Elsewhere, USD/PHP and USD/IDR also edged lower. Also to note, the MSCI Asia ex Japan index is registering new highs at 328 mark, strongest since April 2000. That said, in the absence of fresh impetus the broader USD swings and the local equities market should for now remain the dominant drivers for regional FX. Separately, the yuan rebounded and resumed its march higher against the USD while the MYR recorded its first substantial decline since the China revaluation on July 21. USD/SGD spiked higher in response to USD/MYR upward moves in the later Thursday session. The NEER deviation eased below 0.3% on the strong side accordingly. The slip in MYR yesterday could be correction after the weaker than expected June exports. Nevertheless, we continue to expect gradual downward adjustment for USD/MYR as market impetus to drive the spot lower appear strong and the fundamental backdrop continue to support the MYR.
Claudio PironAC

August 5, 2005

Emerging Markets Research Emerging Markets Today Ben Ramsey (1-212) 834-4308 benjamin.h.ramsey@jpmorgan.com

India Local market comment: Reserve Bank of India appears to be holding back the tide of INR appreciation with USD/INR closing higher at 43.505. Even though high oil prices and strong import demand conspire to provide some USD/INR support, it is apparent that foreign investor appetite for Indian equities knows no end. Cumulative foreign inflows have registered US$6.8 billion so far this year against US$8.5 billion for the whole of 2004, while the Sensex equity benchmark is hitting eight consecutive days of record highs. JPMorgan maintains a year-end USD/INR forecast of 45, wary of the widening current account deficit and stalling reform efforts. Bond markets opened flat on Thursday and traded in a narrow range. There was little trading activity post the BoE rate cut announcement. The 10-year benchmark bond was unchanged and closed at 6.98%.
Shawn TeoAC/Siddharth Mathur

Singapore Local market comment: With UST a touch higher overnight, SGD bonds corrected 2-3bp higher in the morning after the steep 20bp sell-off this week. Selling force emerged again and yields closed 4-5bp higher and the curve steepened another 2bp at 79bp in 2v10-years. SG-US spreads compressed again by 8bp in 10 years and 4-5bps in the short end. With the 10-year IRS closing at 3.04%, convincingly above 3%, the momentum should carry into today.
Vivien WangAC

Korea Local market comment: Korean bonds started strong on Thursday, triggered by USTs 4bp overnight rally, but wasnt able to rally through due to the resistance level of 4.30% for 3-year bonds and 109.80 for futures. The market closed about 1bp higher than yesterday with a 5bp range move. MoFEs comment on improvement in economic fundamentals may hurt the market sentiment as MoFEs low rate policy stance is interpreted to be weaker by the market.
Vivien WangAC

Hong Kong Local market comment: USD/HKD traded narrow from open 7.7730/35 level and found support at 7.7720. Market paid no attention to the rebound in USD/JPY, but rather put its faith in further CNY revaluation. Forward curve steepened with an ease off in the front end up to three months and tightened the most in one year by 6bp (driven by the strong buying interest out of Singapore). HK-US IRS spread also widened by 2-6bp with 4-year and 10-year widening the most.
Vivien WangAC

August 5, 2005

Emerging Markets Research Emerging Markets Today Alfredo.ThorneAC (52-55) 5540-9558 Ben Ramsey (1-212) 834-4308 alfredo.e.thorne@jpmorgan.com benjamin.h.ramsey@jpmorgan.com

Mexico
Policy easing only in December
Banxico in no rush to start its easing cycle; JPMorgan forecasts this starting in December after the wage negotiation seasonality Banxico in no rush to set a policy rate target and want to exercise the additional discretion offered by using el corto as its policy instrument Congress to discuss the 2006 budget and Securities Law in the session that starts in early September Next government compelled to address the widening fiscal deficit, resulting from failure to address the widening social security deficit AMLO is the most likely winner in the 2006 elections, but dont rule out surprises and the PRI is well-positioned to take the lead in early 2006 Early in the week we had our routine quarterly round up of meetings with government officials and local political analysts. Our main conclusion is that we are approaching the end of the fixed income and FX rally. Short term ratespricing a near term easinglook expensive and may rebound once Banxico makes it clear that it wont ease until year end. We keep unchanged our call for a 25bp easing in early December. The middle and long term of the curve is more attractive, although the continuation of the rally depends very much on banks covering their short positions, a process which started this week. After this finishes, the rally may be over. Regarding FX, the high carry makes short USD/MXN position attractive. But this is gradually changing as a result of the US Fed continuing its tightening cycle and Banxico starting its easing cycle. Political noise remains subdued and should keep quiet until the three parties complete their primary elections, which should end sometime in November. Key to watch is the PRI primary process that should start in two weeks time when Roberto Madrazo steps down as party president and Elba Esther Gordillo takes over. Yesterday the nonmadrazistas (TUCOM, an Spanish acronym for All united against Madrazo) chose Arturo Montiel as their candidate to face Madrazo in the primary elections.

Local market views and recommendations With our reinforced view that Banxico will not ease until December, we also confirm our view that additional strength in the long-end of the curve will not come as fast as we have seen since rates peaked in April; rather we should remain in a more rangebound dynamic. Positioning for a bullish steepening in the short-term of the curve, however, is still premature. While long-term rates benefited from two consecutive months of better than expected inflation data and market talk of possible new benchmarks for pension fundspresumably prompting better buying from some of themwe do not see clear drivers for further rates compression in the very shortterm. Inflation readings will actually be under some seasonal pressure and annual inflation rates will not fall below 4% until later in the year. We see inflation rates below 4% and a relaxed monetary stance (which again, we do not expect until December) as conditions for long-term rates to continue rallying towards what we consider fair levels. We prefer curve positions like our current 2s/5s/10s barbell recommendation on TIIE swaps, or trading basis between Bonos and IRS when market conditions allow. In FX, while the carry should continue to be supportive for the peso and we do not rule out the peso testing mid-10.50s levels, we continue to foresee risks for some correction over a three-month horizon. Since the US-Mexico rates differential does not favor long USD/MXN positions (i.e., the cost of betting on a weaker peso via forwards is expensive), we rather advocate exploring FX options structures to position for a weaker peso, with lower costs than forwards. We recently recommended buying a 3-month USD/MXN seagull structure by selling a 30D USD put (strike 10.60), selling a 25D call (strike 11.07), and buying 50D USD call (strike 10.80) (see Emerging Markets Today dated July 29).
Eric TorresAC

In detail, the following were the key messages: No near term policy easing. Although Banxico has a dovish view of inflation performance, the central bank is not ready to ease. The authorities confirmed that inflation was coming down nicely and should fall below the 4% top of the inflation target band sometime in September (chart 1). But they insisted that inflation falling below 4% was not a precondition for starting the

August 5, 2005

Emerging Markets Research Emerging Markets Today Ben Ramsey (1-212) 834-4308 Alfredo.ThorneAC (52-55) 5540-9558 benjamin.h.ramsey@jpmorgan.com alfredo.e.thorne@jpmorgan.com

easing cycle. Indeed, the authorities emphasize that their target is 3% and not 4% and they will ease when they see inflation converging to the 3% (see market expectations in table 2). They were ambiguous on how this will work and hinted that will start easing when they see inflation moving in the 3% direction and will be a forward-looking and gradual process.
Chart 1: CPI headline and core inflation
%oya, using monthly index,. shaded area is forecast 5.5 Headline
5.0 4.5 Banxico's target ceiling 4.0 3.5 3.0
Source: JPMorgan

by year end. Key negotiations are IMSS, Pemex and the Teachers Union. The first two negotiations have already started and should reach an agreement sometime in early September.
Chart 2: Seasonality in nominal wage
Number of workers benefited, thousands
500 400 300 200 100 0 2004 2001 - 2003 avgerage

Core

Jan Feb Mar Apr May Jun

Source: JPMorgan

Jul

Aug Sep Oct Nov Dec

2004

2005

Table 1: Market expectations on Banxicos monetary easing Difference in basis points using Cetes and IRS interest rates (as of Jul 29) Tenor 7 28 60 91 120 150 180 270 365 Date to maturity Difference versus Difference versus JPM maturity O/N Cete O/N IRS forecast Aug 05 -17 -10 0 Sep 05 -17 -13 0 Oct 05 -5 -13 0 Nov 05 -4 -11 0 Dec 05 -7 -12 0 Jan 06 -10 -14 -25 Jan 06 -15 -15 0 May 06 -47 -12 -50 Aug 06 -39 -9 -50

Shift to a policy rate will be gradual. The authorities argue that are in no hurry to adopt a policy rate target, although they agree that de facto they are in a policy target regime. In favor of delaying this process is the additional discretion in monetary policy as they can allow the interest rate to fluctuate around the current 9.75% repo level without making any commitment. In fact, they hinted that they can let the repo rate fall below (or increase above) this level by not setting a floor on the daily auction. Eventually they will announce a policy target, but are waiting for the right time, which may well be by year-end or after the elections. Fiscal policy to remain tight. The Ministry of Finance argues that fiscal policy will remain tight. They are under pressure to spend the oil windfall gains, but these resources are already pre-committed to Pemex investment program and the local governments infrastructure investment fund. The authorities will comply with the 0.1% of GDP headline deficit target and keep the PSBR below 2% of GDP. Budget and Security Laws in focus. The government should submit the 2006 budget in September 8; the authorities expect congress to discuss this and the Securities Laws in the session that starts on September 1. The budget discussion may well be more difficult than previous years, as opposition parties may exert pressure

Source: JPMorgan

Wage negotiations a key driver. Short term, Banxico is closely monitoring wage negotiations, which they see as a potential source of inflation. They cited the acceleration in core service inflation (excluding housing) as a possible indicator of wage inflation. Upcoming wage negotiations coming out on the low side of the 4.0 to 4.5% range should signal that inflation is under control and that there is no wage pressure. This may well be a precondition for the start of the policy easing

August 5, 2005

Emerging Markets Research Emerging Markets Today Alfredo.ThorneAC (52-55) 5540-9558 alfredo.e.thorne@jpmorgan.com

to increase expenditure ahead of the upcoming presidential elections. More challenging would the approval of the Securities Law, which is facing opposition (in the form of lobbying from one large corporate in particular). Next government to address the fiscal deficit. Whoever wins the 2006 elections will have to address the widening fiscal deficit resulting from the widening in social security deficit and the increasing expenses on the Pidiregas and IPAB loans. Failure to address these expenditure pressures could lead to a broader headline deficit to about 2% of GDP from its 0.1% current level. Most parties economic teams are aware of this pressure, but only the PRI and PAN are willing to address this imbalance by passing some of the structural reforms in the congressional session that starts in September 2006immediately after the elections and before next government takes over. But in the case of the PRD, this party seems reluctant to push for any fiscal reform. AMLO most likely winner, but do not dismiss the PRI. AMLO is leading the polls with 42% of the valid voting intentions, followed by Madrazo with 25% and Santiago Creel (PAN), who is trailing in third with 20%. But these polls remain inaccurate as there are about 40% of the voters undecided and could swing the vote in any direction. The PRIs strong performance in the recent gubernatorial elections place it as a strong rival to AMLO in the final leg of the presidential race. There is little doubt AMLO will lead when the election campaign formally starts sometime in December, but the PRI may well move ahead in early 2006, at the height of the election campaign. Much depends on the PRI primary elections and the cohesion of the party during the election campaign.

Conference Call Announcement

Mexico Economic Outlook
Wednesday, August 10 11:00 am (New York time)
SPEAKER REPLAY
From August 11 at 1:00 pm until August at 1:00 pm. Hours are New York time. Callers with 800 access: (800) 633-8284 Callers outside the US: (402) 977-9140

Alfredo Thorne
Chief Economist, JPMorgan Mexico
LIVE BROADCAST Domestic: (888) 939-6307 International: (415) 908-6299

Access Code: 21218159

Callers will be prompted with instructions after calling. Individual tapes will be played for each caller. Callers have the option of winding back the tape 30 seconds (press 7), pausing the tape (press 8), or moving ahead 30 seconds (press 9).

10

August 5, 2005

Emerging Markets Research Emerging Markets Today Vladimir WerningAC (1-212) 834-4144 Ben Ramsey (1-212) 834-4308 benjamin.h.ramsey@jpmorgan.com vladimir.werning@jpmorgan.com Felipe Pianetti (1-212) 834-4043 felipe.q.pianetti@jpmorgan.com

Chile
Upside July CPI surprise testifies to economic strength and favors curve flatteners
We revised up our real GDP forecast to 6.5% due to strength in the business cycle Core inflation is high as BCCh tightening cycle will move forward CLP will remain strong and risks will remain skewed to the upside Market strategy: Pay 2-year fixed versus receive 5year fixed through swaps Chiles CPI was reported at 0.6%m/m (nsa) versus market expectations of 0.4%m/m (nsa). CPI inflation is thus running at 3.1%oya (within the 2-4% central bank target range), marking a visible acceleration from last months reading of 2.7%oya. The inflation report has prompted upward revisions to our forecasts for: 1) real GDP growth; 2) the policy rate; and 3) CLP/USD (see economic discussion below).

activity and trade is improving, dispelling any residual doubts regarding external demand in the quarter ahead. While net trade is not the driver of Chiles economy, there always remains a psychological perception in the market that Chiles growth is very vulnerable to the global engine. As the clouds that may have temporarily appeared in the second quarter have faded, a fear of global growth slippage denting Chiles cycle in the quarters ahead seems a long shot. Core inflation is quite high as BCCh tightening cycle will move steadily forward and the December policy rate is now seen at 4.75%. Core prices were up 0.4%m/m (nsa) in July. Core CPI readings are gradually accelerating from low levels (on an over-year-ago basis) and with core CPI at 2.4%oya are indications that BCCh has been adequately preemptive. But the risk of CPI moving up more visibly ahead is rising. While volatile items may have pushed headline CPI higher in recent months, annualized core inflation since March is running at 5.1%, well above BCChs target range. That measure exaggerates trends since it does not consider seasonal influences, but it serves to underscore the risks bias at the margin. Moreover, while productivity is strong, economic activity is quickly translating into a steady tightening in labor markets, with both real wages and employment moving up in recent months.
Chart 1: Consumer price index
%oya 5
4 3 2 1 0 -1

Market strategy: Pay 2-year fixed versus receive 5-year fixed through swaps
Higher than expected CPI inflation should favor flatteners in the CLP fixed rates curve. We recommend paying 2-year at 4.9% and receiving 5-year at 5.6%, DV01 neutral (1: 0.45) at 70bp slope (indicative). We target 20bp, and set a stop at 90bp. The carry is slightly negative (-0.1% in 3 months), but we deem the curve steepness to be overdone, as the inflation outlook puts the bias towards a more frontloaded tightening cycle. Besides that, the slope is wide to the credit curve (CDS slope is around 15bp), and to the slope between 2s and 5s in the UST curve. The strength in the business cycle is well rooted as 2005 real GDP was raised to 6.5%. We are revising up our forecast for real GDP growth to 6.5% from 6.0% (for 2006 we are now calling for 6.0% growth). Signs have been around for a while that the business cycle expansion in Chile is firm and we have repeatedly pointed to the fact that growth is increasingly drawing strength from domestic demand. Externally, the US (and importantly, the global) data on

Core

Headline

BCCH target range 2003 2004 2005

Source: JPMorgan

The CPI reading obviously confirms the case for a 25bp tightening in next weeks monetary policy meeting. More importantly, we revise up our forecast for the policy rate to 4.75% (from prior 4.25%) by the end of 2005 and keep our forecast of 5.50% for the end of 2006, but with a more front-loaded pace of tightening so that this level is reached by March 2006. We are not revising our year-end 2006 forecast because we believe that countercyclical fiscal

August 5, 2005

11

Emerging Markets Research Emerging Markets Today Vladimir WerningAC (1-212) 834-4144 Ben Ramsey (1-212) 834-4308 benjamin.h.ramsey@jpmorgan.com vladimir.werning@jpmorgan.com Felipe Pianetti (1-212) 834-4043 felipe.q.pianetti@jpmorgan.com

policy today shaves off the peaks and troughs of Chiles cycle and that the burden of leaning against inflation pressures is distributed more evenly between monetary and fiscal policy than in the past. In our view, CLP will remain strong and risks will remain skewed to the upside. We raise our forecast for CLP/USD to 540 for year-end 2005 and 555 for year-end 2006. Our prior forecasts were predicated on risks of weaker BRL affecting CLP, but recent events have shown that regional currencies remain under significant appreciation pressures. Importantly, unlike regional peers who lean against currency strength, BCCh has a more flexible approach to currency markets and CLP should respond to pressure more quickly.
Chart 2: Consumer price index
%m/m (nsa) 1.5
1.0 0.5 0.0 -0.5 -1.0 Jan 03 Impact of CLP appreciation Jun 03 Dec 03 Jun 04 Dec 04 Jun 05 Impact of oil-prices Core Headline

Source: JPMorgan

Several factors should support CLP strength: 1) global growth resilience; 2) support from low inventories for copper prices; 3) domestic demand drivers of growth in Chile; 4) a monetary tightening cycle that is likely to be sped up; and 5) upside risks will be marked by the degree that the investment cycle begins to draw on foreign sources (repatriation of offshore profits or ample availability of market financing) to fund further domestic expansions. Until now domestic funding has not affected CLP; however, this could change given the recent announcement, in particular in the copper sector.

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Emerging Markets Research J.P. Morgan Securities Inc. August 5, 2005

Corporate Spotlight
In this issue Dah Sing Bank, Singapore Telecommunications, and Chaoda Agriculture
Dah Sing Bank (DAHSIN; Baa1/BBB+) Dah Sing Bank announced that it has agreed to purchase Macaus eighth largest bank, Banco Comercial de Macau, and its related life insurance company for a total consideration of HK$1.7 billion, equivalent to 2.5x the net asset value of the target companies. The bank did not detail how the purchase would be funded, but given HK$15 billion of cash and equivalents held at end-2004, we do not expect that DAHSIN will require debt market financing. The purchase is a mild credit positive, as it helps diversify the banks lending profile: Dah Sing has the most domestic-oriented franchise among the Hong Kong banks. We view Dah Sings bonds as fully-valued, however, and remain Underweight, in line with our general recommendation for Hong Kong banks.
Andrea ChengAC

Company Snapshot
Dah Sing Bank is a mid-sized, domesticallyowned Hong Kong bank (US$9.2 billion of assets), with a prominent credit card and vehicle finance franchise.

Singapore Telecommunications (STSP; Aa2/A+) SingTels first quarter results for 2006 were slightly ahead of market estimates as growth in earnings from the associate companies offset continued weakness in Singapore and a slowdown in growth at Optus in Australia. Cash dividends received from associates increased 188%oya, which was not enough to offset declines in free cash flow from SingTel and Optus at the group level, where consolidated free cash flow was down 12%oya to S$594 million. Despite the decline in cash flow, group credit metrics remain robust, with EBITDA interest coverage of 15x, net debt/EBITDA of 1.1x and net debt/net capitalization of only 27%. While net leverage figures should increase in the second quarter following the payment of S$1.7 billion in dividends, credit metrics should remain sound over the near term. In mid-July, Moodys upgraded both SingTel and Optus to Aa2 and Aa3, respectively, as part of its new Government-Related Issuers methodology. We believe this rating is too aggressive, and therefore agree more with Standard & Poors assessment of SingTel as an A+ credit. In terms of relative value, we think the market tends to agree with Standard & Poors as well. SingTels bonds did tighten by about 5bp following the upgrade, but we believe they are trading in line with other A+ rated industrials and telecoms globally. Given that, the bonds do trade inexpensively for a AA-rated name, but as we continue to see SingTel as an A+ name, we therefore see the bonds as fairly valued and retain our HOLD recommendation. We do not see any catalysts in the next three months for the bonds to outperform.
Allison Bellows TiernanAC

Company Snapshot
SingTel is Sin gapores incumbent telecommunications provider. The SingTel group also owns the #2 telecom company in Australia, Optus, as well as significant investments in mobile companies throughout Asia.

Allison BellowsAC
(61-2) 9220-1553 allison.bellows@jpmorgan.com

Andrea ChengAC
(852) 2800-8028 andrea.k.cheng@jpmorgan.com

Fred KamAC
(852) 2800-8086 fred.f.kam@jpmorgan.com

The certifying analyst(s) is indicated by the notation AC. See last page of the report for analyst certification and important legal and regulatory disclosures.
August 5, 2005

www.morganmarkets.com
13

Emerging Markets Research Emerging Markets Today Fred KamAC (1-212) 834-4203 Joyce Chang(852) 2800-8086 joyce.chang@jpmorgan.com fred.f.kam@jpmorgan.com

Chaoda Agriculture (CHAODA; Ba3/BB) At the current price of US$98.50, the Chaoda notes trade a spread of 172bp above Dole Foods 7.25% 2010 Notes, which we consider to be the best global comparable. Adjusting for Doles 2-notch lower credit rating by 60bp, Chaoda looks even more attractive as a high yield play. Closer to home, Chaodas notes trade 90bp wide of Sino Forests 9.125%, 2011 Notes on a spread basis. In addition, investors can pick up US$10.50 from switching from Sino Forest into Chaoda. Lastly, this bond is paying in excess of 172bp versus the average JPMorgan BB-index further illustrating the relative value offered by this opportunity. We recommend a BUY on Chaoda 7.75% 2010 Note base on the 400bp spread pickup over treasuries and the issuers substantial financial flexible, besides its attractive relative value to its peers.
Fred KamAC

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August 5, 2005

JPMorgan Emerging Markets Research Contact Information

Joyce Chang, Global Head of Emerging Markets Research, Foreign Exchange, and Commodities (1-212) 834-4203 joyce.chang@jpmorgan.com G LOBAL S TRATEGY
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