@Capital Flows to Bric Countries

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Capital Flows to BRICs Countries

Eduardo Pedreira Collazo

BBVA ResearchDepartment

Capital Flows

Latin American and Caribbean EconomicAssociation

Mexico - November 2nd, 2006

Javier Santiso

Economista Jefe/Director Adjunto

Centro de Desarrollo OCDE

Miguel A. Canela

Facultat de MatemtiquesUniversitat de Barcelona


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IntroductionI

Focus on equity flows and preliminary resultsII

VAR models: impulse response analysisIII

ConclusionsIV


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Introduction

From a practitioners point of view, we consider extremelyimportant to understand or unveil which factors underlycapital flows to emerging markets, in particular equityflows.

Arguments are based on: international factors (global) and

improvement in local emerging market fundamentals andinstitutions (pull)

More recently, excess liquidity and risk aversion.

Evidence regarding global-local factors is far from beingconclusive about their relative importance. Very few evidencefor liquidity or risk aversion.


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Introduction: Global liquidity and low interestrates

The sharp decline in interest rates,and global excess liquidity hasbeen underlying the surge ofprivate portfolio flows in the last

years. Investors' strategies search for yield - deepened thistrend, leading to record inflows in2005 and 2006:1Q.

Global Interest Rates(GDP-PPP weighted)vs.

Stock of Liquidity(billions)

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Mar-9

5

Mar-9

6

Mar-9

7

Mar-9

8

Mar-9

9

Mar-0

0

Mar-0

1

Mar-0

2

Mar-0

3

Mar-0

4

Mar-0

54000

5000

6000

7000

8000

9000

10000

11000

Interest rate

Liquidity


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Introduction: Investors' risk appetite

Investors' appetite for risk isnot fixed over time. Besidesthat, they shift their portfolioallocation according to theirexpected return andperception of risk.

Any onset of increased investor caution elevates risk premiums and, as aconsequence, lowers asset values and promotes the liquidation of the debt thatsupported higher asset prices. This is the reason that history has not dealt kindlywith the aftermath of protracted periods of low risk premiums. Alan Greenspan

Global Risk Aversion Index Indice - IARG64 assets: emeging (dollars) and developed (local curencyl)-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.01.0

2.0

3.0

4.0

jun

-95

ab

r-96

feb

-97

dic

-97

oc

t-98

ago

-99

jun

-00

ab

r-0

1

feb

-02

dic

-02

oc

t-03

ago

-04

jun

-05

ab

r-06

Source: BBVA - Capital Flows.

+ aversion

- aversion


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Introduction: In general, improvedfundamentals


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Introduction: : Compressed EM sovereignspreads

Sound macro fundamentals, highcommodity prices and global

growth, compressed EM spreadsto historical levels, below 200bp.

EMBI+(lhs) vs.USCorporate spread BAA(b.p.)

200

400

600

800

1000

1200

1400

1600

1800

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

50

60

70

80

90

100

110

120

130

140

150

EMBI BAA-AAA


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IntroductionI



ConclusionsIV


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Focus on equity flows and preliminary results

Many researchers studied FDI, bonds or reserves, butmuch less efforts have been dedicated to explainprivate equity flows.

Many researchers studied FDI, bonds or reserves, but muchless efforts have been dedicated to explain private equity

flows.

We are interested in Private Equity Flows

We use equity flows data from EPFR. Data are collected from

a universe of 12,000 international, emerging markets andUS funds, with more than $5.7 trillions in assets.

Investors are worldwide based and not only in US.


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Correlation: flows, local & global factors

A previous exploratory factor analysis, based on principal components, pointsto a four- factor structure, with DEMBI, DCOMM and MSCIW standing alone,and the other five associated to the remaining factor. This structure accountsfor an 85% of the variance.


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Preliminary regression results


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IntroductionI



ConclusionsIV


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A negative shock in global interest rates is associated with increased cumulative flows in LatinAmerica, whereas for Asia we observe a slight decrease.

VAR: Cumulative impulse responseanalysis


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Even though the results are mixed, the evidence for Asia gives supportfor the expected return chasing hypothesis.



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Panel C give supports to the hypothesis that capital flows are, in part,momentum driven. In the short-run Latin America could suffer a slightlydecrease, but in the long--run both regions will be benefited.



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VAR: Cumulative impulse response analysis

The effects of a negative shock in global interest rates in long--runreturns is not clear. Panel D suggests that in the short-run these regionswill experiment a lower cost of capital, but in the log--run these pressureeffects might reverse themselves.


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VAR: Contemporaneous effects

The effects of a negative shock in global interest rates in long--runreturns is not clear. Panel D suggests that in the short--run theseregions will experiment a lower cost of capital, but in the log-run thesepressure effects might reverse themselves.


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IntroductionI



ConclusionsIV


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Conclusions

Even though local factors have been improving during the last

decade, the role of global factors is more important.

That is, equity capital can flow into (or out) of a country forreasons other than local fundamentals.

Risk appetite can have an important role

We found that positive returns shocks are followed byincreased short-term equity capital flows, indicating amomentum effect (Bohn and Tesar 1996).

A negative shock in global interest rates is associated with

increased cumulative flows to Latin America.

A negative shock in global interest rates will temporallyreduce the cost of capital, but in the long-run this effect isreversed.

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