Washington, DC, January 18, 2007 — Total net private capital flows to emerging markets continued at a strong pace in 2006, but the volume is forecast to ease somewhat this year in line with an expected moderation in world growth, according to the Institute of International Finance. Last year's total at $502 billion was just below the record of $509 billion in 2005, and the IIF projected that this year's volume will be around $470 billion.

The IIF is the global association of financial institutions with more than 360 members in over 60 countries. In its report today, Capital Flows to Emerging Market Economies, the IIF said the volume of capital flows recovered vigorously in the second half of last year following turbulence in global financial markets in the May-June period. The year saw historically tight spreads on emerging market sovereign bonds over U.S. Treasury yields with non-bank net flows (mostly bonds) exceeding $100 billion for the second consecutive year. In addition, last year witnessed record high emerging market share prices accompanied by net portfolio equity inflows of close to $70 billion, after $56 billion in 2005.

The IIF forecasts that 2007 net direct investment could set a new high level of $211 billion following $185 billion in 2006. Asia, led by China, remains the largest regional source of direct investment inflows, but the new report highlighted, in particular, the rapid rise of direct investment into Central and Eastern Europe. The IIF reported that net commercial bank flows in 2006 exceeded $140 billion for the second year in a row and it projected a lower 2007 volume at around $100 billion.

Dr. Josef Ackermann, Chairman of the Board of Directors of the Institute of International Finance (IIF) and Chairman of the Group Executive Committee of Deutsche Bank AG, stated, "The substantial volume of capital flows to emerging markets that is now being seen reflects both the strong economic fundamentals in a considerable number of countries and the high levels of global liquidity. Although we anticipate continued robust investment flows into emerging markets this year, it will be necessary for the authorities of emerging market countries to reinforce economic policies, notably structural initiatives that promote fiscal and pension reforms. Such actions are most timely given the uncertainties that exist concerning the sustainability of current global liquidity levels. "

Dr. Ackermann noted, "It is important to underscore that sustaining a healthy environment for the global economy and international finance requires still greater efforts by the leading G7 industrial countries and the major emerging market countries to coordinate policies to reduce global imbalances and to guard against protectionist pressures. Leaders need to make every effort at this time to secure a successful outcome to the Doha Round of trade negotiations."

Mr. William Rhodes, IIF First Vice Chairman, Chairman, President & CEO, Citibank N.A., and Senior Vice Chairman, Citigroup Inc., stated, "Investors have been impressed by the further improvements that have been made in economic fundamentals in a number of emerging market economies. In countries such as Mexico and Brazil inflation has been further reduced and external positions have been strengthened. In addition, we have continued to see high levels of growth in China and India that have secured formidable foreign investor interest. But there are potential downside risks in emerging markets' finance, which require more vigilant risk-management approaches by investors and sustained sound economic by emerging market governments."

Mr. Rhodes pointed out that, "Given today's geo-political and global economic uncertainties it is important to ensure actions on current account imbalances, trade and the financial system itself. Recent official bilateral U.S.- China economic discussions need to be reinforced by broader approaches by major governments and the IMF that can lead to the unwinding of the imbalances. Moreover, securing the very real benefits of globalization demands that the leading industrial countries set aside the concerns of influential special interests and forge a constructive multilateral trade agreement."

Mr. Rhodes added, "It is particularly timely that we are now seeing significant progress on strengthening the architecture of the global financial system through the implementation of the Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets. The Group of Trustees of the Principles, comprising financial leaders from the public and private sectors, has been established and there have been meetings on a range of individual country situations by the Principles Consultative Group (PCG), which includes investors and creditors and emerging market officials."

Commenting on today's report, IIF Managing Director Charles Dallara stated at a press conference that, "The rising levels of emerging market capital flows reflect the increasing integration of these economies into the world economy. This is very evident with regard, for example, to foreign direct investment flows where we are not only seeing rising flows into an increasing number of emerging market economies, but we are also seeing major foreign acquisitions by companies headquartered in the emerging market countries"

Mr. Dallara said, "We anticipate a record level of net foreign direct investment flowing into emerging market economies this year with Asia-Pacific again in the lead. China continues to be the largest single recipient with inflows again likely to exceed $50 billion. The momentum of India's economy is increasingly attracting flows of direct investment, while Indian firms are expanding their own overseas investments. Substantial direct investment activity is being seen, in particular, in both Brazil and Mexico within the Latin American region. We are also seeing a substantial rise in direct investment in a number of countries in Europe, with Turkey and Russia being particularly notable."

The IIF's report noted that the stellar performance of capital flows in recent years as well as emerging market asset prices is not solely due to the improvement of fundamentals and favorable global economic conditions. An increasing number of institutional investors, including from hedge funds and pension funds, have joined the ranks of traditional investors in the asset class helping to support flows and asset prices. The emergence and now deepening of local markets, the introduction of new types of securities, particularly derivatives, and asset securitization into country financing programs, and an extension in maturities has left emerging markets debt more manageable than at any other previous point in the history of the market. However, the IIF pointed out that the rapid growth of non-traditional participants in emerging markets and the widespread use of credit derivative have added new, complex elements to financial markets, which have not been fully tested in a severe market correction.

Economic Growth Forecasts

The IIF's First Deputy Managing Director and Chief Economist Yusuke Horiguchi noted at the press conference that, "Central to our forecasts today are our expectations of continuing economic growth in the leading industrial economies. We anticipate that the U.S. economy will regain forward momentum relatively early in 2007 commensurate with its potential growth rate of around 3 percent but, reflecting the carry over effect of the slowdown in the second half of 2006, the annual average growth rate for this year is projected at 2 ¾ percent, down from 3 ¼ percent in 2006. At 2 ¼ percent, economic growth in the Eurozone should again be above its potential rate of a little less than 2 percent, while we see growth in Japan sustained at 2 ¼ percent pace this year."

The IIF forecast 2007 growth for emerging market economies at 6.4 percent, after a 7.0 percent rise last year. It projected significant variations in growth rates between regions.

Forecasts for Capital Flows

Direct Equity Investment: The IIF noted that the environment in emerging markets for direct investment remains favorable. Investment in natural resources is expected to continue to expand. Investment related to research and development will likely intensify, especially in Asia and Europe, which are already experiencing the largest increase in such activities. Services should also gain particularly finance, telecommunications, and real estate.

While the Asia/Pacific region continues to be the largest recipient of net direct investment, the IIF forecast that it is the only region in 2007 that is not likely to experience a further advance. Net direct equity investment is projected to hold at $76 billion, down from the peak of $89 billion in 2005. Although inflows of direct investment to China probably will not return anytime soon to the peak of $68 billion reached in 2005, the large pipeline of commitments nonetheless suggests that net inflows could amount to $55 billion this year the same as in 2006. While net direct investment into India is rising and likely to reach $8 billion this year after $6.5 billion in 2006, the IIF report pointed out on the outflow side annual investment is set to jump nearly three-fold to $3 billion as Indian firms set up production, marketing and distribution networks overseas to achieve global scale.

Central and Eastern Europe, plus Turkey, is likely to see direct equity investment rise to $70 billion in 2007 from $67 billion last year. In Turkey, the momentum from privatization should continue with direct investment at about the same historically high level seen in 2006 at around $22 billion this year. Net direct investment to Russia is forecast to exceed $12 billion, making it the second largest recipient of this type of investment in the region.

Net direct investment in Latin America is expected to rebound to $45 billion in 2007 after falling below $29 billion in 2005. The major recipients are Mexico and Brazil, with each seeing net direct investment inflows this year of around $13 billion. This represents a decline of about $3 billion for Mexico compared to 2006. Meanwhile, Brazilian companies invested heavily overseas last year and this resulted in net outflows of $6 billion. In the Africa/Middle East region, net direct equity investment is projected to reach a record level of more than $19 billion this year, following net inflows of nearly $13 billion last year. Egypt is expected to eclipse South Africa as the recipient of the largest amount of direct investment in the region, taking in $6.5 billion of net flows this year. A surge in direct investment has been driven by a boom in privatization and strong regional liquidity.

Portfolio equity investments: Mr. Horiguchi noted, "We are seeing record levels of portfolio equity investment flows and it is important for the authorities of emerging market economies to recognize that sustaining foreign confidence over time is going to require significant strengthening of their domestic stock market regulatory frameworks and the promotion of high corporate governance standards."

The IIF stated that emerging market equity prices rose 29 percent in 2006, marginally below the 30 percent recorded in 2005. After reaching an all-time high of $70 billion in 2006, emerging market portfolio equity investment is projected to decline this year to about $63 billion. China saw record inflows of $32 billion last year, but a more modest level of around $18 billion is forecast for 2007. The spate of IPO activity in 2006, which included the world's largest such listing, is likely to recede in 2007 as fund raising activity by state-owned companies and banks drops off.

Bonds: The IIF noted that at the end of 2006, the spread on the EMBIG index for emerging market bonds stood at 171 basis points above U.S. Treasury bonds, which was one basis point above the all-time low spread for the index set on December 28, 2006. For the year, this index recorded a total return of 9.9 percent.

In volume terms, the IIF is forecasting that net nonbank private sector lending, largely in the form of bond purchases, is likely to moderate somewhat this year to total $93 billion this year, after $103 billion in 2006. Europe is projected to account for 68 percent of nonbank private creditor flows to emerging markets this year, up from 62 percent in 2006. However, net flows are expected to hold steady at $63.5 billion. Russia is likely to account for nearly 45 percent of the flows to the region this year. Net nonbank flows are expected to fall slightly below the 2006 record of $30 billion. Russian corporations will account for most of the borrowing with issuance spread among financial, telecommunication and natural resource companies.

Net nonbank creditor inflows to the Asian/Pacific region are expected to decrease from $30 billion in 2006 to $23 billion this year. The region's share of total net nonbank flows to emerging markets is projected to fall to 25 percent from 29 percent last year, representing the lowest share since 2003. Following net repayments of $1.6 billion to nonbank creditor last year, the Latin America region is projected to receive net inflows this year of $1.3 billion as Venezuela experiences a sharp reversal in flows. Two countries in the region, Brazil and Mexico, however, will have net outflows.

Bank Flows: Net commercial banks lending is projected to exceed $100 billion in 2007, the fifth consecutive year of positive flows albeit down from the record level of $143 billion last year. The sharp drop in net lending stems from the repayment of short-term loans connected with leveraged buyout (LBO) transactions that rose significantly in 2006. In addition, authorities in some countries are attempting to reduce credit growth as part of overall demand management policies. Net commercial bank lending to Central and Eastern Europe, plus Turkey, is forecasted to decline to $71 billion this year from nearly $81 billion in 2006. Despite this decline, this region will still receive 70 percent of net commercial bank lending to emerging markets this year. In the Asia/Pacific region, net commercial bank lending is projected to be $29 billion this year, down from $44 billion in 2006.

Official Flows: Repayments to official institutions from emerging market economies have exceeded new loans and credits by these institutions for several years. The IIF forecast that 2007 net repayments to these creditors are likely to be about $2 billion, compared to $48 billion made last year and $58 billion in 2005. The bulk of this year's repayments is expected to be made by Algeria, Indonesia and Turkey.

Reserves: The IIF reported that foreign exchange reserves of the leading 30 emerging market economies that are covered in the new report rose by $536 billion in 2006, after a gain of $440 billion in 2005. A further rise in reserves of $506 billion is seen as likely in 2007.