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1 January 29 th 2014 Emerging markets dividend policy challen nges recent scares in emerging markets havee forced investors to react. Wee highlight movements in CDS, options volatility, short selling and ETFF markets. Looking forwards, new dividend research highlights the impact of government set payout ratios for emerging market large caps. Is this another cause for investor concern? Dividends across MSCI s Emerging Market (EM) index are forecast too grow 2% to $225 billion BRIC companies account for half of all dividends, yet form only a thirdd of the index Short interest in heavy outflows the two major EM ETFs, EEM and VWO, has leapt higher in the face of Latin America s largest dividend payer, Ecopetrol sees very heavy borrowing in its ADRs Background Just as the great and the good of the business world were gathering at Davos to talk about their cautious optimism for economic growth, along comes a storm of worry about emerging markets. Markets weree inching higher until late last week but all indices are now down year to date given how much exposure today s large firms have to emerging markets. This diversification of sales swings violently from a strength to weakness. We are now several weeks into falling currencies in the BRICs as well as countries such as Argentina, Turkey, South Africa, Brazil and Ukraine. most cited reason for this sell off is the Fed s tapering plans. Investorss think that reduced bond buying by the world s biggest central bank will hit the weakest the hardest. This could be the countries with the biggest current account deficits or those struggling with the reforms that are necessary to make their companies globally competitive. Another bump in thee road was the Markit Flash China Manufacturing PMI that fell below 50 for f the first time in six months, denoting a contractionc n in activity. chart shows s a significant spike in CDS spreads forr our indexx of EM companies, to a level not seen since last August. But, beforee anyone becomes too alarmist, implied volatility data for the EEM ETF show that there is a long way to go before the recent worries translate into the kind of panic seen in 2011 when the EU crisis was at its height.

2 ETF Short Interest This mountain of worry manifests itself in a spike in short interest in the ETFs that track the main emerging markets indices. Vanguard EM ETF has seen demandd to borrow hit a three year high while the ishares equivalent shows a spike but short interest was higher than this last summer. Dividend Dampener Markit recently added emerging markets to its repertoire of places where we forecast dividends and this is timely given their heightened importance. types of company large enough to be included in the MSCI index are typically those with high degrees of state ownership by virtue of often being banks or utilities. se firms are typically mandatedd to pay a minimum level of dividend. But, as this table for the MSCI EM index shows, the average % of earnings (net income) being paid out in dividends ( average payout ratio ) is a staggering 38%.. re are two principal drivers for an enhanced focus on dividends: cash-squeezed governments targeting extra money to plug holes in their budgets; and an attempt to lure overseas investment in domestic companies by exploiting the knownn search for yield from the international investors from the t US and Europe wheree interest rates are low. EM ETF AUM flow Investors have seen nearly $4bn pulled from all of the ETFs that track the MSCI Emerging Markets index in the year to date, according to Markit ETF s Analytics. Dividend Policy P in Brazil Brazil is thee one BRIC nation where we see dividends dropping. d Corporate law in Brazil states companies aree required to pay out a minimum 25% of earnings, butt our forecasts show the actual average level to be well above

3 this. This is because the utility sector is so well represented in Latam, a sector which typically has high payout ratios. This mature industry will remain a source of consistent payouts and currently offers high relative yields.. However in 2012 the Brazilian government enacted regulations on the Utility sector, essentially creating price caps on prices charged to consumers. This had a huge impact on 2012 earnings and indirectly crushed dividend payouts. This year we see dividends dipping further, based on consensus analyst expectations of marginal to zero growth in earnings. Russia Russia has just 17 constituents of the MSCI EM index, yet we expect them to declare dividends totalling over $18.1bn, up 3% on last year. Payments will be boosted by new legislation from the Kremlin demanding its majority state owned companies distribute 25% of profits and, like China. Our forecastss show an average payout at this level. Almost all companies are set to comply, the exception being the banks, which still need to boost capital. re is talk that this will be upped yet further to 35% for profits in average yield of 3.9% is witness to these positive developments and looks only set to grow. An Eastern European neighbour, Poland, also has seen the state ncreasing its dividend receipts from most of its state owned companies last year and will do so again this year. India Indian treasury t needs to boost its receipts to reach a self-imposed budgett target. A few companies have increased dividends and a few have paid p a one-off interim to expedite dividend payments including a couple of state owned banks. India s fundraising push included an unexpectedly generous $3bn dividend announced last week from Coal India, which is roughly 90 per centt state-owned, providing a windfall forr the finance ministry. Despite most of the cash rich Public Sector Units trying to pay higher dividends/expedite payments, Oil O PSUs (ONGC and Oil India) are expected too pay flat or just marginally higher dividends due to high capex plans and subsidies too downstream oil companies. China For China the t push comes from pressure to reform China into a developed economy to attract foreign investors implying greater transparency in dividend decisions and greater answerability to shareholders. Chinese governmentt is cash rich so dividends aren t needed to make up for a deficit elsewhere saw a minimum payout recommendation brought in, guiding companies to pay out 30% of profits in cash dividends. This guidance was reiterated inn November. While this t rule is not mandatory, it certainly applies pressuree to listed companies not paying cash dividends. Markit data for this year showss the average payout across the region will be 30%. big names are partly or indirectly owned by the government, so most of them already pay cash dividends at the target level. This is expected too persist. However, over a third of the constituents showw a payout below 25%,

4 showing there s scope for further growth future years. Biggest dividend payers in Will Duff Gordon Research Director Markit Tel: will.duffgordon@markit.com For further information, please visit Colombia Colombia is a bright spot with a combination of record low inflation/ low unemployment and the highest GDP growth among the countries covered. However, Colombian state-owned Ecopetrol, as can be seen in the table, is the largest dividend payer in Latin America and is in trouble: the share price has dropped some 40% on concerns over sustainability. In December it announced a $10.6bn increase in capex to boost output. With earnings forecast to come in lower, we seee a dividend cut this year. Rumours abound regarding about whether the CEO will go, and might be replaced by a political appointee. All of this is not lost on short sellers who have long seen this coming and been borrowing increasing amounts of Ecopetrol s ADRs for some time. Thomas Matheson Dividend forecasting Markit Tel: thomas.matheson@markit.com

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