Emily Vogl, Frank Vogl
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Capital Flows to Emerging Markets Set at Close to Record Levels
IIF Leaders Call for Prudent Risk Management Given Market Vulnerabilities. Record Direct Investment Seen. Stocks of International Reserves Soar
Athens, Greece, May 31, 2007 — Net private capital flows to emerging markets reached a record of over $550 billion last year, up from $520 billion in 2002 and they are on target in 2007 to match the 2006 volume, stated the Institute of International Finance (IIF) today in a report released at its Spring Membership Meeting in Athens.
The IIF is the global association of financial institutions with more than 360 member institutions across the world. Dr. Josef Ackermann, Chairman of the IIF's Board of Directors, Chairman of the Management Board and of the Group Executive Committee of Deutsche Bank AG, said, "The current level of flows reflects a generally positive economic environment. We continue to see solid growth and low inflation in the leading industrial economies. There are also improvements in economic fundamentals in many emerging markets. In addition, as emerging market assets have performed well, there has been a progressive widening of the investor base, enhancing the resilience of emerging markets as a result."
Dr. Ackermann stated at a press conference in Athens at the Spring Membership Meeting of the IIF that there are vulnerabilities in the economic outlook, which make it particularly important for borrowers and investors alike to pursue prudent risk management. He noted that current concerns include geo-political issues, uncertainties in a range of major national economies, including the United States and China, as well as the potential of the global imbalances igniting a disorderly adjustment. He said, "Next week's G8 Summit should address the issue of imbalances and encourage the process of the multilateral negotiations under the auspices of the IMF. To provide effective political support to this process, however, requires that the forum of G7 Finance Ministers be expanded to a G11 to include countries that now are key players on the global economic stage - China, India, Russia and Brazil."
IIF Senior Vice Chairman William Rhodes, Chairman, President and CEO of Citibank N.A. and Senior Vice Chairman of Citigroup Inc., stated on current capital flow trends that, "Due to high levels of liquidity and the chasing of yield, we are seeing a lack of differentiation in the pricing of various financial assets in global markets today. The time has assuredly come when investors need to differentiate much more carefully between various types of risks, and to price risks according to fundamentals."
Mr. Rhodes added, "At the same time, given the market vulnerabilities that now exist, the governments of a rising number of emerging market economies need to maintain sound economic policies and pursue needed structural reforms - in some cases these have been postponed for much too long."
The IIF's capital flows forecasts are predicated on expectations that there will be only a modest slowing of economic growth this year relative to 2006. U.S. growth is seen at 2.4 percent after 3.3 percent in 2006, while Eurozone growth is forecast at 2.5 percent after 2.8 percent, and growth in Japan this year is projected to be unchanged from last year's 2.2 percent. Growth in emerging market countries is slated to remain robust at 6.8 percent, down slightly from 7.1 percent in 2006. Substantial variations are evident among the regions, with the IIF forecasting more than 8 percent growth for the fourth year in a row in emerging Asia, a slight slowing in emerging Europe to 6.2 percent from 6.4 percent, a decline to 4.7 percent from 5.2 percent in Latin America, and growth in the Africa/Middle East region is expected to taper off in 2007 to 5.0 percent from 5.2 percent.
Key features of the new IIF report include:
- Net direct investment is projected to rise to a record $194 billion from $167 billion last year. Emerging Asia continues to dominate in this category led by China, which is expected to attract $58 billion in net inflows. While the majority of FDI is from companies in the major industrial countries, the IIF noted that companies based in emerging markets-”both private and state-owned-”are gaining a significant and growing presence. Competitive pressures are but one factor driving emerging market companies to expand overseas. The rapid growth of large emerging market countries like China and India is causing concerns about the availability of, and access to, key resources and inputs for continued economic expansion. Outward investment from emerging market countries is likely to translate into broad benefits and enhanced competitiveness for these countries, contributing to improved export performance, higher national income and better employment opportunities.
- Portfolio equity investment is expected to decline from last year's $51 billion to $42 billion in 2007. Although emerging market equity prices hover at record levels, valuations remain reasonable at 14 times 2007 earnings for the benchmark index. Moreover, in some markets valuations are lower and are supported by strong fundamentals. The broader appeal that the asset class seems to have engendered among long-term investors like pension funds seems likely to continue. The development of derivatives markets in some emerging market countries could also bring more attention from hedge funds and other investors looking for leverage opportunities.
- Net lending from commercial banks is forecast to decline to $173 billion this year from a record high $198 billion in 2006, due to significant repayments of short-term loans. For the fifth consecutive year, emerging Europe will receive the largest amount of net lending from this source. Today's report noted that the way some banks have changed their lending practices in recent years has helped to spur lending to emerging markets. In particularly, a growing number of banks no longer set specific country lending limits but look at companies as stand alone entities. These banks realize that the premier borrowing names in many emerging market countries are world class companies operating in a global economy rather than just their home market. Moreover, given the extent to which pricing of loans has fallen for top corporate names in advanced industrial countries, lending to quality companies in emerging markets makes good business sense as they can provide better returns for the corresponding risk.
- Net non-bank private lending (mostly bonds) is likely to hold steady at $136 billion. A decline in net sovereign borrowing is expected to be offset by corporate bond issuance as firms take advantage of investors' continued search for yield. The continued improvement in the profile of emerging market external sovereign debt reflects the steady strengthening of economic fundamentals, increased reliance on domestic issuance, adherence to sound policies and proactive use of liability management. These factors have contributed to a steady improvement in the overall credit rating of emerging market debt, which now stands slightly below BB+.
- Lending from official creditors this year is projected to be positive for the first time in six years. Net official inflows are expected to be slightly above $1 billion in 2007 following net outflows of $64 billion last year.
- Foreign Exchange Reserves. The report noted that 2007 will see the ninth consecutive year of gains in reserve accumulation by emerging market countries - when this trend started in 1999 reserves of the countries in the IIF's survey totaled $57 billion; in 2007 they are forecast to rise by nearly $670 billion. This will bring the stock of international reserves to almost $3.4 trillion, representing about nine months of imports of goods and services for these countries-”an all-time high. The Asia/Pacific region is likely to account for more than 70 percent of the total emerging market reserve accumulation this year. China's reserve accumulation could reach $375 billion in 2007, up from $252 billion last year. Reserve accumulation in emerging Europe is projected to slowdown to $101 billion this year, after hitting a record high $125 billion in 2006 as Russian reserves increase by $80 billion, down from $107 billion last year. Reserve accumulation in Latin America and Africa/Middle East is expected to rise marginally in 2007.
Strengthening the International System
Dr. Ackermann stated at the press conference that, "A paramount issue for the IIF's members with regard to emerging markets is strengthening the architecture that can prevent crises and manage them well should they arise. With today's IIF report noting that net official capital flows to emerging markets are expected to amount to just $1.3 billion this year, compared to $550 billion from the private sector, it is obvious that the private sector has a major role to play on the crisis prevention stage."
He said that leaders of official finance and the private sector have been moving forward to implement the "Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets." Dr. Ackermann stated, "This framework for pragmatic action based upon voluntary market practices was launched in late 2004. Support for the implementation of the Principles is growing. This has been helped by the engagement of a number of major public officials as Trustees, and permit me to just single out ECB President Jean-Claude Trichet, who inspired this initiative originally and who continues to provide leadership. Today, we are seeing more governments recognizing the need to improve their investor relations and data transparency, and more investors who realize that cooperation on preventing crises can help avoid costly restructurings."
Major emerging markets included in the IIF's report on capital flows are the following:
Emily Vogl, Frank Vogl