CEIC News@lert: CEIC Initiative: Analysis of Capital Flows to Emerging Markets
January 29, 2014
In the past quarter CEIC has distributed a series of thematic analytical reports focused on the increased volatility in international capital markets and its impact on Emerging Market Economies (EMEs).
In several News@lert, Data Talk and Macro Watch articles CEIC has discussed the external vulnerability of EMEs by evaluating, among other features, the composition, denomination, maturity, and ownership structure of public and corporate debt, as well as the Balance of Payments and International Investment Position statistics, equity markets performance, and exchange rate regimes. We have also presented cross-country comparisons of sustainability indicators such as the level of monetization, foreign-exchange reserves coverage, and market capitalization as a share of GDP.
Since the 2007-2009 financial crisis EMEs have provided attractive investment opportunities for international investors seeking to diversify away from the advanced economies mired in sluggish growth and with squeezed profit margins. The persistently high GDP growth differentials and interest rate spreads between the advanced economies and the EMEs have been widely recognized as key determinants of much of the international capital flows.
As buoyancy returns to the US and Europe, and the talk of potential monetary policy normalization in the US gains momentum, the odds are high that many investors will consider reallocating some of their assets out of emerging markets with weak fundamentals. For instance, countries with persistently high budget and current account deficits are most likely to be hit by sudden capital reversals. Political turmoil may prove to be another salient factor weighing down confidence in some countries.
The vulnerability of EMEs to swings in investor sentiment has become evident over the past few days when the news of a slowdown in GDP growth in China and sharp depreciation of the Argentine peso triggered what many analysts described as a “flight to safety” – a sell-off of equities and currencies across a diverse spectrum of EMEs. As of Monday, January 27th, the MSCI Emerging Market Index had lost more than 7% since the beginning of 2014.
The dominant concerns are that, rather than being isolated cases, such episodes of evaporating confidence may become the norm in the foreseeable future. Last year, there was plentiful evidence of EMEs’ susceptibility to exogenous shocks and consequent contagion. In the second and third quarters of 2013, many EMEs suffered from considerable foreign capital withdrawals, with declines being more pronounced in the emerging economies of Central Europe. For instance, in the third quarter of 2013, Hungary experienced net capital outflow amounting to 19% of GDP – a 7.8 percentage point decrease in its net capital balance compared to the same quarter of the previous year. Large capital outflows were also evident from Turkey, Mexico and the Philippines, among other countries.
A large share of the volatility in capital markets in 2013 has been attributed to the U.S. Federal Reserve’s intention, announced in June, to taper its bond-buying programme (known as quantitative easing). It is yet to be seen if, and to what extent, the Fed’s decision from December to begin scaling back its asset purchases, will affect the EMEs, as its monetary policy is still expected to remain rather accommodating with the policy rate unlikely to rise imminently, given current inflation and unemployment expectations.
With unsustainable domestic policies, deteriorating fundamentals and political uncertainties affecting some EMEs, the challenging external conditions leave open the possibility that the slowdown in capital inflows may end up escalating into full-blown capital stops, and by extension into a potential balance of payments crisis in economies ill-equipped to adopt adequate measures to counter sudden capital reversals.
The current consensus among economic analysts is that 2014 will be a turbulent year for emerging markets. There are sizeable downside risks owing to the anticipated foreign capital withdrawals, the improving fundamentals arising from upbeat economic sentiment in the U.S. and Europe, and the associated narrowing of interest rate differentials between developing and developed markets. Nevertheless, it has been pointed out that the economic upturn in the U.S. and Europe may actually prove to be a welcome development for some EMEs. For instance, countries that are net exporters to the advanced economies are poised to benefit from the increased demand from developed markets.
Thus, CEIC will continue to monitor the performance of EMEs relative to their developed counterparts and disseminate regular briefs containing analysis of any significant developments in international capital markets, and of EMEs’ external debt dynamics and sustainability.
CEIC Data Manager provides recourse to timely country-specific statistics necessary to assess the performance of the EMEs capital markets. Of primary interest are data contained in the Government and Public Finance, Balance of Payments, Interest and Foreign Exchange Rates, and Financial Market sectors, located in the Global Database. In addition, the Global Economic Monitor section of the World Trend Database offers quick access to country-specific data for a selection of some of the most important and widely used indicators.
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