JUNE 2011

Emerging Markets Overview

OVERVIEW The quarter started with positive stock market performances, with fund flows into emerging markets turning positive in April, after two consecutive months of net outflows. Markets, however, took a turn in May as focus shifted to debt restructuring issues in the eurozone. Concerns that the debt crisis could spread to larger economies such as Spain and a downgrade of Greeces credit ratings led investors to adopt a more risk averse position. The postponed disbursement of European Union (EU) funds to Greece, coupled with political uncertainty in the country, further heightened market volatility in June. However, the survival of Prime Minister George Papandreou in a vote of confidence, the passing of austerity measures by the Greek parliament and promises of a second bailout from the EU in July led markets to turn around. Against this environment, emerging markets ended the quarter with a 1.0% decline in US dollar terms. REGIONAL UPDATE The Chinese economy grew 9.7% year-on-year in the first quarter of 2011, in line with the 9.8% year-on-year growth in the final quarter of 2010. Key growth drivers included trade and investment. In an effort to curb liquidity and inflation, the Peoples Bank of China raised its one-year deposit and lending interest rates by 25 basis points (0.25%) to 3.25% and 6.31%, respectively. This was the Banks second increase this year. The reserve requirement ratios were also increased by 150 basis points to 21.5% for large banks and 19.5% for smaller banks. Inflation reached a record high, with consumer prices rising 5.5% year-on-year in May, compared to an increase of 5.3% year-on-year in April. Growth in Foreign Direct Investment flows into China eased to 15.1% year-on-year in April, from 32.9% year-on-year in March. Inflows totalled US$8.5 billion in April, with about 25% going into the property sector. As part of efforts to cool the property sector, the government plans to double the land supply available for residential development this year, compared to the previous two years. South Koreas Gross Domestic Product (GDP) grew 4.2% year-on-year in the first three months of 2011, due to strong exports and recovering domestic demand. This was, however, lower than the GDP growth of 4.7% year-on-year in the last quarter of 2010, mainly due to a decline in investment. Greater domestic demand led retail sales growth to rebound to 4.9% year-on-year in March, from a decline of 0.8% year-on-year in February. Unemployment fell to 3.7% in April, from 4.3% in March, mainly due to job creation in the private sector. While year-on-year growth in exports moderated in May, it remained a healthy 23.5%. This compared to an increase of 25.1% year-on-year in April. Inflationary pressures eased in April and May due to lower retail petrol prices. South Koreas four oil refiners agreed to cut gasoline and diesel prices for the 3-month period ended July. The Consumer Price Index (CPI) eased to 4.1% year-on-year in April and May. This compared to an increase of 4.7% year-on-year in March. The Central Bank raised its key interest rate by 25 basis points (0.25%) to 3.25% in June to curb inflationary pressures and home-loan growth. This was the Banks third increase this year. The South Korean parliament ratified the free trade agreement with the European Union; it will take effect on 1 July. The Indian economy grew 8.5% year-on-year in the fiscal year ended March 2011. This compared to an increase of 7.4% year-on-year in the previous fiscal year. GDP grew 7.8%

Dr. Mark Mobius

Executive Chairman, Templeton Emerging Markets Group

FRANKLIN TEMPLETON INVESTMENTS

MARKET UPDATE JUNE 2011

year-on-year in the quarter ended March, compared to 8.3% year-on-year in the last three months of 2010. The moderation in growth was primarily due to the manufacturing and services sectors. Financial services and agriculture, however, supported growth. The Reserve Bank of India increased the benchmark interest rate by 25 basis points (0.25%) to 7.5% in June, to combat inflationary pressures. This followed a 50 basis points (0.5%) increase in May. The increment in May was the largest in the current tightening cycle. The Bank has raised rates by 2.75% since early 2010. Wholesale prices increased 9.1% year-on-year in May, mainly due to high oil prices and strong domestic demand. Industrial production growth eased to 6.3% year-on-year in April, from 8.8% year-onyear in the previous month, due to weaker growth in manufacturing production. Growth in manufacturing output moderated to 6.9% year-on-year in April, from 10.4% year-on-year in March. GDP growth in Brazil eased to 4.2% year-on-year in the first quarter of 2011, from 5.0% year-on-year in the final quarter of 2010. Weaker domestic and external demand were the key reasons for the moderation, with growth in consumer spending, exports and fixed investment easing in the first three months of the year. The CPI exceeded the upper limit of the governments 2.5%-6.5% target range. Prices rose 6.6% year-on-year in May, compared to 6.5% year-on-year in April. On a month-on-month basis, however, inflation eased to 0.5% from 0.8%, as lower fuel prices led to lower transportation costs. The Bank increased its key interest rate by 50 basis points (0.5%) to 12.25% during the quarter. The Central Bank has raised interest rates four times this year to curb inflation. In an effort to increase greater trade and investment relations as well as regional security, US President Barack Obama met President Dilma Rousseff during his visit to Brazil in March. A number of bilateral agreements were signed. Moreover, President Dilma Rousseff visited China in April, where both countries signed a number of cooperative, economic and investment accords. South Africas GDP growth accelerated to 4.8% quarter-on-quarter in the first quarter of 2011, its fastest pace in a year. Year-onyear, the economy grew 3.6%, compared to 3.8% in the final quarter of 2010. The largest contributor to growth was the manufacturing sector, which grew 14.5% quarter-on-quarter. After three interest rate cuts in 2010, the Reserve Bank continued to leave its benchmark interest rate unchanged during the quarter, despite higher inflationary pressures. The key interest rate remained at 5.5%, its lowest rate in more than three decades, to support the domestic economy. The CPI rose to a 12-month high of 4.6% year-on-year in May, from 4.2% year-on-year in April. This was mainly due to higher petrol prices. The rate, however, remains within the Banks 3%-6% target range. In politics, the ruling African National Congress (ANC) won the municipal elections with 62% of the votes. The opposition Democratic Alliance (DA) received about 22% of the votes. GDP growth in Russia eased to 4.1% year-on-year in the first quarter of 2011, from 4.5% year-on-year in the final three months of 2010. Weakness in the investment sector was the main reason for the moderation in growth. The Central Bank of Russia increased the benchmark refinancing and deposit interest rates by 25 basis points (0.25%) to 8.25% and 3.5%, respectively, to curb inflationary pressures. Consumer prices rose 9.6% year-on-year in May. Unemployment fell to its lowest level in more than two years as Russias strong economic recovery led to the creation of more jobs. Unemployment decreased to 6.4% in May, from 7.2% in April. Higher employment also led to greater consumer demand with retail sales continuing to record healthy growth rates. May sales rose 5.5% year-on-year, in line with the 5.6% year-on-year increase registered in April. High oil prices led exports to jump 37.6% year-onyear to US$46.1 billion in May. Similarly, imports surged 39.9% year-on-year to US$26.8 billion due to stronger domestic demand. This led to a record trade surplus of US$19.3 billion for the month, and compared to a surplus of US$17.3 billion in April. While Turkeys Central Bank left its key interest rate unchanged at 6.25%, it raised the reserve requirement ratio for short-term lira liabilities by 100 basis points (1.0%) to 16.0%. The reserve requirement ratio for short-term foreign exchange liabilities was also raised. The CPI jumped to its highest level in more than ten years in May. Prices increased 7.2% year-on-year in May, compared to 4.3% year-on-year in April. Higher food, transport as well as clothing and footwear prices led to the higher inflation. In politics, as expected, the ruling Justice and Development (AK) party emerged victorious, winning about 50% of the votes in Junes parliamentary elections. The countrys strong economic recovery from the financial crisis is seen as one of the reasons for the partys popularity. The Turkish economy grew a strong 8.9% year-on-year in 2010, compared to a 4.8% contraction in 2009. However, despite its strong victory, the party failed to achieve a three-fifth majority in parliament, which would have enabled it to push through constitutional changes without opposition support. OUTLOOK Market volatility is a reality of today and in view of the continued growth of credit and derivatives, that volatility is expected to increase. It seems that in recent years, the word volatility has lost its true meaning since so many market participants use it to mean a down or bear market. Its important to remember that volatility goes both ways, up and down, and that volatility can be positive since it gives investors an opportunity to purchase shares at low prices when share prices decline excessively, and sell at high prices when prices rise excessively. One of the reasons we have (and are likely to continue to see) this level of volatility is because of the occasional misuse of derivatives. Misusing these financial instruments contributed significantly to the global financial

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MARKET UPDATE JUNE 2011

crisis in 2008, and they continue to be used today. The total value of derivatives in the world at the end of 2010 was more than US$600 trillion. Thats 10 times the worlds total GDP.1 We cannot exactly predict when the next market correction will hit us, nor know how great or small it will be, but we do realise that market volatility is here to stay. Few of the problems that caused the 2008 financial crisis have been resolved - banks are bigger than ever, and the derivatives market continues to grow and complex derivatives remain largely opaque and illiquid. It is heartening to see that international policymakers are trying to work toward a global regulatory standard, but until we find a true, long-term solution to these problems, we cannot ignore the possibility of another financial crisis stemming from derivatives. But, as a long-standing English proverb tells us, we can hope for the best and prepare for the worst. With every crisis comes great opportunity. Therefore, we continue to invest with a long-term horizon in companies that we believe are undervalued, fundamentally strong and growing, and those that we think can weather through difficult times. Our long-term, ground-up, disciplined investing approach has kept us in good stead through the volatility so far and, we believe, could see us through potential crises or corrections. FOOTNOTES 1. Derivatives A collective term for financial instruments which derive their value from an underlying reference asset (commodities, indices, individual shares) or a notional amount. Examples of derivatives are futures, options and contracts for differences. Emerging market investments can be volatile and investors should be prepared to hold an investment for the long-term. IMPORTANT INFORMATION Copyright 2011. Franklin Templeton Investments. All rights reserved. This document is intended to be of general interest only and does not constitute legal or tax advice nor is it an offer for shares or invitation to apply for shares of any of the Franklin Templeton Investments fund ranges. Nothing in this document should be construed as investment advice. Franklin Templeton Investments has exercised professional care and diligence in the collection of information in this document. However, data from third party sources may have been used in its preparation and Franklin Templeton has not independently verified, validated or audited such data. Opinions expressed are the authors at publication date and they are subject to change without prior notice. Any research and analysis contained in this document has been procured by Franklin Templeton Investments for its own purposes and is provided to you only incidentally. Franklin Templeton Investments shall not be liable to any user of this document or to any other person or entity for the inaccuracy of information or any errors or omissions in its contents, regardless of the cause of such inaccuracy, error or omission. The value of shares in a Franklin Templeton Investments fund and income received from it can go down as well as up, and investors may not get back the full amount invested. Past performance is no guarantee of future performance. Currency fluctuations may affect the value of overseas investments. When investing in a fund denominated in a foreign currency, your performance may also be affected by currency fluctuations. In emerging markets, the risks can be greater than in developed markets. For more information about any Franklin Templeton Investments fund, UK investors should contact: Franklin Templeton Investments, Telephone: 0800 305 306, Email: enquiries@franklintempleton.co.uk or write to us at the address below. In Denmark, Finland, Norway or Sweden, please contact: Franklin Templeton Investment Management Limited, Birger Jarlsgatan 4, SE-11434, Stockholm, Sweden. Telephone: +46 (0) 8 545 012 30, Email: nordicinfo@franklintempleton.com.

Issued by Franklin Templeton Investment Management Limited (The Adelphi, 1-11 John Adam Street, London WC2N 6HT and Rensburg Fund Management Limited (RFM) Quayside House, Canal Wharf, Leeds LS11 5PU). RFM is a Franklin Templeton Investments company. Both companies are authorised and regulated by the Financial Services Authority. Franklin Templeton Investment Management Limited is authorised to conduct investment business in Denmark by the Finanstilsynet, in Sweden by the Finansinspektionen, in Norway with Kredittilsynet, and in Finland with Rahoitustarkastuksen.

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