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IIF Publishes New Edition of Flagship Report, Capital Flows to Emerging Market Economies

Zurich, Switzerland, January 22, 2013 — The Institute of International Finance – the global association of more than 470 financial institutions – today publishes its authoritative report, Capital Flows to Emerging Market Economies. Among the wealth of data and insights in the latest edition of this influential 30-page analysis, which is published three times a year, several key issues are highlighted. These include:

  • Private capital flows to emerging economies have revived strongly since mid-2012, thanks to a more risk-friendly attitude by investors. This turnaround was also supported by policy actions, including aggressive monetary easing in mature economies, and also strong fundamentals in emerging market economies.
  • We estimate that overall flows dipped slightly in 2012 year-on-year, to $1,080 billion (against flows in 2011 of $1,084 billion), despite the strong pick-up in momentum in 2012H2.
  • The latest round of easing by the Federal Reserve has given rise to a vigorous debate over the fundamental drivers of capital flows to emerging markets. Is it primarily a ‘push’ phenomenon – i.e., the relaxed monetary policy and the prospect of poor returns in mature economies are pushing money out of those markets? Or is it instead a consequence of strong growth in emerging economies, combined with their higher interest rates, which is ‘pulling’ more funds into those economies? Our analysis suggests that both positions are to some extent correct. The report addresses this push-versus-pull debate by modeling capital flows over the past two decades.
  • Monetary conditions in mature economies remain exceptionally easy. Combined with the favorable growth conditions in emerging economies, this has produced a notable upswing in flows during 2012, and we anticipate this will continue in 2013.
  • However, the ‘easy money’ conditions have perhaps created a false sense of confidence. The potential of a tighter monetary stance by the U.S. Federal Reserve – given the recent rate of decline in U.S. unemployment – implies a degree of heightened risk in the longer term. Perhaps the most pertinent precedent is the experience of 1993-94, when the U.S. Federal Reserve changed course away from its previous ‘low-for-long’ policy and raised interest rates.
  • The importance of China in the context of capital flows is undiminished. However, here there has been a fundamental change in the past year, with the emphasis switching from the public sector to the private. While this may alleviate some tensions (over exchange rates, for example) it may exacerbate others, concerning Chinese ownership of overseas’ corporations.
  • The report highlights the fact that a significant amount of this outward direct investment by China has been destined for other emerging market economies – particularly resource-rich countries – in Africa, Emerging Asia and Latin America.

Commenting on the release of the Capital Flows report, Mr. Charles Dallara, Managing Director of the IIF, said: “This latest edition of one of the Institute’s leading publications highlights the fact that, although the global macroeconomic environment has stabilized in the past few months, there are nevertheless potential risks on the horizon. Notably, concerns over the future of the Euro Area have diminished, and private capital flows to Emerging Europe have recently improved, totaling $193 billion for the whole of 2012. However, that is still a third less than the amount of flows seen in 2005-07. In contrast, capital inflows to Latin America and Emerging Asian markets are now more than 30% above that of 2007. On the more distant horizon, as far as risk is concerned, is the direction of interest rate policy by the U.S. Federal Reserve. Investors may be unprepared for a reversal of interest rates. This needs to be seriously considered to avoid disruption.”

Mr. Philip Suttle, Deputy Managing Director and Chief Economist of the IIF, addressed the ‘push’ versus ‘pull’ debate in the shaping of capital flows. He said: “As so often is the case in economics, both sides are to some extent right. In this report we have constructed an econometric model which analyzes the relative importance of push and pull factors in driving aggregate capital flows over the past two decades. Based on this model it is our view that both these factors have been roughly equally important over the past 15 years.”

The report estimates that capital flows to emerging market economies as a whole totaled $1,080 billion in 2012, $54 billion higher than projected in the October 2012 issue of the report. It forecasts this will rise modestly in 2013, to $1,118 billion, an upwards revision of $18 billion from last October. As a percentage of mature economy GDP, these flows represent an average of approximately 2.4% in 2012 and 2.5% in 2013. The report points out that, “even with these increases, aggregate flows in nominal terms will remain around 10% below their historic peak, reached in 2007, as commercial banking flows are still subdued.” In 2014 the report projects that capital flows will continue to climb gradually and, on current trends, reach $1,150 billion.

The report covers 30 major emerging market economies, but within this wide sample China remains predominant, accounting for about 40% of all capital inflows. The nature of capital flows in the case of China is shifting – its capital outflows have become an important factor in the global financial system. The report states: “Looking ahead, the role of Chinese investments and lending in the global economy is likely to gain even more importance in coming years, with important implications for both mature and emerging market economies.”

Capital outflows from China have, until recently, been driven by policy preferences. However, the Chinese government has eased restrictions on private capital outflows, making it easier for resident Chinese to undertake outward investment and lending. The report calculates that Chinese resident lending to overseas markets has doubled in 2012, to $268 billion. The value of Chinese banks’ total external assets rose by some $203 billion between the end of 2009 and the start of 2013, accounting for around 41% of Chinese resident lending abroad during that period.

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Gary Mead
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E-mail: gmead@iif.com