Zurich and Washington D.C., January 27, 2009 — The Institute of International Finance today forecast a substantial slowing in net private capital flows to emerging markets. It said that the volume of flows is likely to be $165 billion this year, after an estimated $466 billion in 2008, which compares with the record 2007 volume of $929 billion.

"The subdued level of net private capital flows to emerging markets that is in prospect for 2009 is in line with the major slowdown of global economic growth. Indeed, we are now anticipating negative world growth for 2009," said IIF Managing Director Charles Dallara. He noted, "While all components of net private capital flows have recently weakened appreciably, the most significant weakness is for net bank lending where we now see a net outflow from the emerging markets of about $61 billion this year, after a net inflow last year of $167 billion and a record of $410 billion in 2007."

The IIF, which is the leading global association of financial institutions with over 380 members, said that while declines in net private capital flows are expected for all emerging market regions, the most substantial fall from previous levels will be for Emerging Europe, where the projected volume is seen at just $30 billion, after an estimated $254 billion in 2008 and $393 billion in 2007. Net private capital flows into Latin America are expected to be halved, with a forecast 2009 volume of $43 billion following an estimated $89 billion in 2007 and $ 184 billion in the previous year. For Emerging Asia, the projected volume of inflows is $65 billion, after $96 billion last year and $315 billion in 2007.

The IIF said that the recession and the financial crisis in the mature economies are the prime causes of the prospective declines in net private capital flows to emerging markets. Significant reductions in oil and other commodity prices are also key factors. Growth in the mature economies will be negative 2.1 percent this year after plus 0.9 percent in 2008, said the IIF. Emerging markets are expected to see further real growth, but with a gain of only 2.7 percent this year after 5.7 percent last year. Overall, global output is likely to see negative growth of 1.1 percent in 2009 after a 2.0 percent advance in 2008.

Key Policy Concerns

Speaking at a press conference in Zurich today, William R. Rhodes, First Vice Chairman of the IIF's Board of Directors, Chairman, President and Chief Executive Officer, Citibank and Senior Vice Chairman, Citi, stated: "The prospective 2009 declines in private capital flows raise major questions about potential capital shortfalls to emerging market countries at a time of severe economic strains."

Mr. Rhodes said, "The governments and central banks of many emerging market economies have pursued sound policies in recent years, curbing inflation, promoting investment, building significant reserves, indeed strengthening their overall economic fundamentals, while also pursuing institution building. As a result, quite a number of countries are now better placed than in earlier times to face the economic storms. But, there is no room for complacency. Vigilance on the part of leaders of the emerging market economies is all the more important given that their countries are susceptible to contagion from the mature economies, which will face enormous tests throughout this year. Indeed, there is a clear case for initiatives that ensure that the efforts made by these emerging market countries are backed with international official support."

Mr. Rhodes said, "I have underscored since the IMF annual meetings in Singapore in 2006 that the mature economies will confront serious economic challenges that will have a major impact in emerging markets. Last October, at the IIF press conference in Washington, I stressed the need for explicit actions by the IMF. While we welcome the measures that the Fund has taken, including the introduction of the short-term liquidity facility for market access countries with strong policy track records, this program can only be effective if the maturities are longer and if the amounts available are increased. The IMF's resources need to be expanded and its approaches modified to provide financing to emerging markets that have been caught in a crisis not of their making. The IMF needs to move with speed to support fully the economic policies that emerging market countries are now pursuing to mitigate the impact of the recession in the mature economies."

At the press confrence, Mr. Rhodes stated, "We would like to see actions that support the well performing emerging market economies as part of the broader strengthening of the global economy and reform of the architecture of the financial system and here the Group of 20 meeting in London in April will be particularly important. These actions need to be undertaken with a spirit of strong partnership between the public and the private sectors. I also want to emphasize that keeping trade open and guarding against protectionism is essential."

He stressed that, "In addition, the IIF has consistently highlighted the need for reforms of regulatory and accounting standards. We are proposing the establishment of a Global Financial Regulatory Coordinating Council to promote implementation of global standards in the major markets. On accounting, we have been proposing a high-level dialogue on standards with a view to establishing convergence and a level playing field, while at the same time mitigating the procyclical effects of current accounting standards and addressing the issues around fair value accounting at times of illiquid markets."

Speaking at the Zurich press conference, Roberto Setúbal, IIF Vice Chairman and President of Banco Itaú Holding Financeira S/A of Brazil, said, "Many of the leading emerging market economies have entered this very difficult period in healthier economic condition than in the periods of crisis in the 1990s and in the 1980s, with lower inflation levels, stronger reserves, more pragmatic and more prudent economic policy leadership. At the same time, the leading banking institutions in many emerging market economies, which have largely avoided direct involvement in the sub-prime crisis, are not suffering from the same degree of distress as those in the mature economies. I am confident that both the public and private sectors in our economies will continue to move decisively to put in place the policies that these stressful times require."

The IIF said that private sector borrowers face at least $100 billion of repayment obligations on their market-based borrowing that fall due in the first half of this year. Philip Suttle, IIF Global Head of IIF Economic Research, said that, "At the current level of market access, borrowers seem able to issue not much more than half this total falling due. Policy makers in both mature and emerging markets would be well advised to address this refinancing problem head on in the weeks and months ahead."

The new report pointed out that the stresses during the recent and current phase of weak growth for emerging market borrowers result mainly from difficulties in rolling over market-based debt under conditions where it is not just their own prospects that have deteriorated, but also those of their lenders. Moreover, borrowers in emerging markets now face the prospect of being "crowded out" by the massive borrowing needs of G10 governments.

Weak bank lending

The report noted that the strains in the global banking system, which have seen a major curtailment in new credit, have impacted flows to emerging markets in 2008 and are likely to have a still more pronounced impact on flows in coming months. The most affected region is emerging Europe where net banking flows peaked at $217 billion in 2007 of which $107 billion was accounted for by Russia. Last year these flows fell to $123 billion, with Russia accounting for $28 billion. The IIF is projecting that this year net repayments by borrowers in this region to commercial banks will be about $27 billion with Russia repaying $49 billion, net.

In the case of Emerging Asia, banking net flows declined last year to just $30 billion from $156 billion in 2007. For 2009, the IIF forecast repayments to banks of $25 billion. The bulk of the adjustment between 2007 and 2009 is accounted for by Korea, where net flows are forecast to show a negative swing of $87 billion during the period, and by China and India, which are set to see swings respectively of $52 billion and $32 billion. The magnitude of the banking shock on Latin America is seen as less severe where net banking inflows of $31 billion in 2007 are seen giving way to net outflows in the current year of $ 12 billion.

Non-bank credit flows

The IIF said that non-bank lending (mostly bonds) to emerging markets is likely to amount to $31 billion net this year, down from $125 billion last year and $222 billion in 2007. This year may see rising demand by emerging market sovereign borrowers in the markets as they adopt more expansionary fiscal policies. Mr. Suttle noted, however, that a number of Latin American sovereigns - Argentina, Ecuador and Venezuela, do not currently have access to the international markets, while governments in a number of Emerging European countries, notably those with IMF programs, will be required to run contractionary, rather than expansionary, fiscal policies.

Equity Investment

IIF First Deputy Managing Director and Chief Economist Yusuke Horiguchi noted that net foreign direct investment flows to emerging markets have historically been more stable and a similar pattern is expected for 2009. Despite the global downturn in growth, it is likely that these flows will total over $195 billion, compared to around $260 billion last year and $304 billion in the prior year. He said, however, "Our forecasts for FDI have to be viewed with some caution given a significant decline in global capital spending that is underway, the erosion of corporate profits;, and the decline in commodity prices may lead to lower new international investment in extractive industries. In addition, global weakness in real estate prices will curb FDI in the construction sector, notably in the tourism and residential areas."

Net portfolio equity flows were strongly negative in 2008 amounting to $89 billion, and the IIF forecast that, with equity positions smaller and prices much lower, outflows this year are likely to be modest at around $3 billion.

Including GCC flows

The IIF pointed out that its regular reports on capital flows to emerging markets have concentrated on countries that have typically been significant borrowers in international markets. However, with capital flows from emerging markets having grown to outweigh capital flows to emerging economies, and the oil producing countries of the Gulf Cooperation Council (GCC) being particularly important in this intermediation process, the IIF standard sample for this report is being expanded from 28 to 34 countries to include the six from the GCC to provide a somewhat different perspective. The external financing picture for this larger group of 34 countries is shown in Table 2 below. The main difference between the two samples is the varying degrees of current account adjustment. Including the GCC countries means a larger decline in the overall current account surplus for emerging economies. In turn, this means less capital to export in 2009 compared to 2008, whether in the form of outward portfolio equity investment (about $168 billion less), resident lending (about $350 billion less), or official reserve accumulation (about $324 billion less).