Capital Flows to Emerging Markets MAY 28, 2015

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Capital Flows to Emerging Markets MAY 28, 2015MAY 28, 2015MAY 28, 2015MAY 28, 2015

� After a slow start to the year, private capital inflows to EMs are projected to cool to

$981 billion in 2015, their lowest level since 2009. For 2016, we project a pickup to

$1,158 billion.

� The projected drop in inflows in 2015 reflects disappointing EM growth, a challenging

global interest rate outlook, and country-specific factors such as the Russia-Ukraine

conflict.

� The acceleration in inflows in 2016 assumes a gradual Fed exit, a pickup in EM growth,

and reduced political uncertainties.

� Resident capital outflows are projected to stabilize in 2015—with a continued shift

towards private sources and away from official reserve accumulation.

� We stress downside risks to our capital flows outlook related to (1) continued

stagnation in global growth and (2) more aggressive Fed rate increases that could be

prompted by further U.S. labor market tightening.

� In these scenarios, capital flows to EMs would be even weaker in 2015 and would not

experience the marked rebound in 2016 that we project in our baseline case.

� Fallout from a potential EM stress event would be exacerbated by a lack of secondary

market liquidity and increased corporate indebtedness across EMs.

The outlook for 2015 EM capital inflows has deteriorated since our January report. We

now forecast private non-resident inflows to decline from $1,048 billion in 2014 to $981

billion this year, which would be the weakest outcome since the global financial crisis.

Moreover, inflows are projected to slide to 3.5% of EM GDP, the lowest level since 2002.

In part, the weakness in flows projected for 2015 reflects developments that have already

occurred as we estimate that capital inflows reached a six-year low in 2015Q1 in the

context of weak EM GDP growth (Chart 1).

Table of Contents Overview 1 Growth Acceleration Delayed 5 Alternative Scenarios 8 Spike in Global Risk Aversion 10 EM Reserve Slowdown 13 EM Corporate Debt Risks 15 EM Liquidity—How Bad? 20 Emerging Asia 25 Emerging Europe 27 Latin America 29 Middle East 31 Sub-Saharan Africa 33 Tables and Annex 34

Chart 1Chart 1Chart 1Chart 1

GLOBAL MACROECONOMIC ANALYSIS

Felix Huefner CHIEF ECONOMIST [email protected]

Robin Koepke ECONOMIST [email protected]

Arpitha Bykere ASSOCIATE ECONOMIST [email protected]

Scott Farnham RESEARCH ANALYST [email protected]

Litia Shaw SENIOR PROGRAM ASSISTANT [email protected]

CAPITAL MARKETS & EMERGING MARKETS POLICY

Sonja Gibbs DIRECTOR [email protected]

Emre Tiftik FINANCIAL ECONOMIST [email protected]

Fiona Nguyen SENIOR RESEARCH ANALYST [email protected] Khadija Mahmood RESEARCH ANALYST [email protected]

Charles Collyns CHIEF ECONOMIST [email protected]

Hung Tran EXECUTIVE MANAGING DIRECTOR [email protected]

150

175

200

225

250

275

300

3.0

3.5

4.0

4.5

5.0

12Q4 13Q2 13Q4 14Q2 14Q4e 15Q2f 15Q4f 16Q2f 16Q4f

EM GDP Growth 4-Quarter MA

Total Capital Inflows 4-Quarter MA

IIF Forecast

Source: IMF, National Sources, IIF.

$ billionEMEMEMEM GDP Growth and Total EM Capital InflowsGDP Growth and Total EM Capital InflowsGDP Growth and Total EM Capital InflowsGDP Growth and Total EM Capital Inflowspercent, q/q, saar


page 2 CAPITAL FLOWS TO EMERGING MARKETS | MAY 28, 2015


Looking ahead, a key assumption is that the Fed tightening trajectory is broadly in line

with current economist consensus expectations—i.e. liftoff later this year and 4 hikes of

25 basis points each over the course of 2016. In this case any fallout should be limited

and concentrated on the more vulnerable EMs. However, it is important to highlight the

high degree of uncertainty surrounding market reactions to actual Fed hiking of policy

rates. Even if the Fed's schedule and trajectory of rate hikes are consistent with current

expectations, markets can become jittery on the occasion of actual rate hikes to the

detriment of EMs. Moreover, the two main risk scenarios to our baseline point to further

weakness in capital flows to EMs, rather than the revival we project for 2016 in our

baseline (pages 8-9). First, there could be a protracted slowdown in both emerging and

mature economy growth that would reduce incentives for cross-border investment, even

with lower interest rates. Second, the Fed may raise policy rates by more than expected,

perhaps in response to tightening conditions in labor markets even in the face of

moderate growth due to a weakening on the supply side of the U.S. economy.

Portfolio flows have continued to be volatile over the past few months. Introduction of

QE by the ECB and a shift in market expectations towards a slower Fed exit supported

portfolio flows in the first few months of 2015 (Chart 2). Subsequently, portfolio flows

suffered a retrenchment in May in the context of a sharp increase in mature economy

bond yields, led by a jump in bund yields that seems to have been related to a

stabilization in global oil prices and some alleviation of disinflation concerns. According

to our new Flows Alert, which aims to identify episodes of flow surges and reversals on a

real-time basis, the reversal episode lasted 18 days and was widespread across countries.

We estimate that total EM portfolio outflows in this episode may have amounted to

around $10-15 billion, compared to $35-50 billion during the taper tantrum of 2013

(Chart 3).

For 2015 as a whole, we project portfolio equity flows to climb to around $130 billion, a

30% increase from 2014 (Table 1), helped by improving EM economic prospects as the

year progresses and relatively attractive valuations (Chart 4). Portfolio debt flows will


-30

-20

-10

0

10

20

30

40

50

Jan 14 May 14 Sep 14 Jan 15 May 15

Debt

Equity

Total

TotalTotalTotalTotal NonNonNonNon----Resident Portfolio Flows to Emerging MarketsResident Portfolio Flows to Emerging MarketsResident Portfolio Flows to Emerging MarketsResident Portfolio Flows to Emerging Markets$ billion

Source: IIF.

2010-14 Average: $22 bn


6

8

10

12

14

16

18

2005 2008 2011 2014

Forward P/E RatiosForward P/E RatiosForward P/E RatiosForward P/E RatiosMSCI indices, price-to-12Mforward earnings estimates, dotted line=period average

Developed Markets

Emerging Markets

Source: MSCI, Datastream, IIF.

-1.6

-1.2

-0.8

-0.4

0.0

0.4

0.8

1.2

1.6

Apr 13 Oct 13 Apr 14 Oct 14 Apr 15

Confidence Band7-Day MA28-Day MA

Daily EM Equity and Bond FlowsDaily EM Equity and Bond FlowsDaily EM Equity and Bond FlowsDaily EM Equity and Bond Flows$ billion, all available countries (7)

Taper Tantrum

Oil Price and Ruble Collapse

Spring 2014 Surge

January 2014 Correction

Taper DelayRally

Flows Alerts (Selection)

Bund Bund Bund Bund TantrumTantrumTantrumTantrum

Source: IIF.

AAAA key assumption key assumption key assumption key assumption is that the Fed is that the Fed is that the Fed is that the Fed tightening tightening tightening tightening trajectory is trajectory is trajectory is trajectory is broadly in line broadly in line broadly in line broadly in line with current with current with current with current economist economist economist economist consensus consensus consensus consensus expectationsexpectationsexpectationsexpectations

https://www.iif.com/publications/flows-alerts



continue to be dampened by nervousness about rates in advance of Fed exit and less

favorable valuations compared to asset classes like U.S. high yield bonds (Chart 5).

Overall, we forecast these flows to be flat at around $170 billion.

Foreign direct investment (FDI) accounts for a large portion of the decline in capital flows

projected for 2015 (Table 1). We project FDI inflows to fall to $530 billion this year from

$580 billion in 2014, led by reduced inflows to China and Russia. Nonetheless, FDI

remains by far the largest (and most stable) source of external financing, and is likely to

account for around half of total non-resident inflows this year.

On a regional basis, a major factor behind the marked decline in total capital inflows in

2014/15 is the conflict between Russia and Ukraine (Chart 6). The slump particularly

affected non-bank lending to Russia (including bond flows), which fell from inflows of $85

billion in 2013 to outflows of $72 billion in 2014. For total non-resident flows to Russia,

we project a further retrenchment to the tune of $33 billion this year, led by bank lending

and portfolio debt flows. In addition, net debt-related inflows to China have turned

negative as Chinese corporates have sought to reduce dollar exposure in the face of

dollar strength, monetary policy easing, and more two-way movement in the RMB.

Resident capital outflows by emerging market investors are projected to stabilize at just

under $1.2 trillion in 2015. We expect the composition of EM outward investment to shift


0

75

150

225

300

375

2010 2012 2014

Differential Between U.S.Differential Between U.S.Differential Between U.S.Differential Between U.S. HY HY HY HY Spread and CEMBI SpreadSpread and CEMBI SpreadSpread and CEMBI SpreadSpread and CEMBI Spreadbasis points

Source: Bloomberg, BAML, IIF.

2000-2015 Average

Table 1Table 1Table 1Table 1

Emerging Market Economies: Capital FlowsEmerging Market Economies: Capital FlowsEmerging Market Economies: Capital FlowsEmerging Market Economies: Capital Flows

$ billion 2013 2014 2015 2016

NonNonNonNon----Resident Capital Inflows Resident Capital Inflows Resident Capital Inflows Resident Capital Inflows 1301130113011301 1090109010901090 1049104910491049 1202120212021202

Private InflowsPrivate InflowsPrivate InflowsPrivate Inflows 1269126912691269 1048104810481048 981981981981 1158115811581158

Equity Investment 666 687 657 725

Direct Investment 582 586 529 561

Portfolio Investment 84 101 128 164

Private Creditors 603 361 325 433

Commercial Banks 172 175 119 184

Nonbanks 431 186 206 248

Official Inflows 33 42 68 44

International Financial Institutions -3 12 34 20

Bilateral Creditors 36 30 34 24

Resident Capital OutflowsResident Capital OutflowsResident Capital OutflowsResident Capital Outflows ----1518151815181518 ----1164116411641164 ----1179117911791179 ----1351135113511351

Private Outflows -978 -1054 -1105 -1065

Equity Investment Abroad -418 -397 -388 -406

Resident Lending/Other -560 -657 -716 -659

Reserves (- = Increase) -540 -110 -74 -286

----217217217217 ----74747474 ----130130130130 ----149149149149

Memo:

Net Errors and Omissions -3 -146 0 0

Current Account Balance 220 220 130 149

Source: IIF. See backcover page for guidance on how to interpret these data.

Net Capital FlowsNet Capital FlowsNet Capital FlowsNet Capital Flows



further towards private sources of capital and away from official reserve accumulation.

Indeed, reserve accumulation is projected to slow to only $74 billion this year from $110

billion in 2014 and an average of $600 billion during 2004-2013. As discussed on pages

13-14, this reduction reflects three main factors: (1) declining oil revenues by major oil

exporters (see page 32), (2) weaker capital inflows mainly in Asian EMs, and (3) a

continued rise in outflows by Chinese corporates (see page 25). Thanks to China,

emerging markets on aggregate remain net exporters of capital (Chart 7). China is

projected to invest $540 billion overseas in 2015 (up $38 billion), of which over 50%

would be resident lending abroad and over a quarter in the form of FDI.


-2000

-1500

-1000

-500

0

500

1000

1500

1995 1998 2001 2004 2007 2010 2013 2016f

"Private" Resident Outflows

Official Reserve Accumulation

Non-Resident Inflows

Net Flows

EM Capital Flows by Residency of InvestorsEM Capital Flows by Residency of InvestorsEM Capital Flows by Residency of InvestorsEM Capital Flows by Residency of Investors$ billion

Source: IIF.

IIF Forecast


-1.5

0.0

1.5

3.0

4.5

6.0

7.5

9.0

10.5

-200

0

200

400

600

800

1000

1200

1400

2000 2004 2008 2012 2016

EM Europe Latin America

MENA EM Asia ex. China

China

Private NonPrivate NonPrivate NonPrivate Non----Resident Capital Inflows to Emerging MarketsResident Capital Inflows to Emerging MarketsResident Capital Inflows to Emerging MarketsResident Capital Inflows to Emerging Markets$ billion percent of EM GDP

Total, Percent of EM GDP

Source: IIF.

IIF Forecast

Thanks to China, Thanks to China, Thanks to China, Thanks to China, emerging markets emerging markets emerging markets emerging markets on aggregate on aggregate on aggregate on aggregate remain net remain net remain net remain net exporters of exporters of exporters of exporters of capitalcapitalcapitalcapital



GLOBAL GROWTHGLOBAL GROWTHGLOBAL GROWTHGLOBAL GROWTH————ACCELEACCELEACCELEACCELERATION DELAYEDRATION DELAYEDRATION DELAYEDRATION DELAYED

Underlying our projections for reduced flows this year and a pick-up in 2016 is a global

macro outlook where growth is led by an acceleration in mature economies, with weaker,

but regionally differentiated growth in EMs. Fed policy rates are expected to be raised

gradually from later this year, but the ECB and BoJ continue their QE programs.

Relative to our January Capital Flows report, global activity has clearly disappointed so

far this year. We now estimate mature economy growth in the first quarter to have been a

mediocre 1.3%, and only 2.6% in EMs—the lowest rate since the global financial crisis

(Chart 8). While activity in Europe and Japan has gathered some momentum, growth

faltered in both the U.S. and China. More broadly, the global impact of lower oil prices

on consumption was less favorable than previously thought. Also, any beneficial

consumption effect was offset to varying degrees by cutbacks in investment (particularly

in the U.S.) and government spending (in EM oil exporters).

We still expect an acceleration of growth in the remainder of 2015 and 2016, as

temporary factors weighing on U.S. activity unwind, as stimulus measures have an impact

in China, and as conditions improve in a number of other EMs that have been very weak,

notably Brazil and Russia. Nonetheless, as reported in our April Global Economic

Monitor, we have reduced our 2015 global GDP forecasts by around 1/3 percentage

point, with lower annual growth in Latin America, the MENA region and in the U.S.

(Chart 10). Lower EM growth particularly affects FDI and banking inflows, which are

expected to suffer as a result (Chart 9).

DIVERGENT DIVERGENT DIVERGENT DIVERGENT MONETARY POLICY MONETARY POLICY MONETARY POLICY MONETARY POLICY ---- UNEASY BACKUNEASY BACKUNEASY BACKUNEASY BACKDROP DROP DROP DROP FOR PORTFOLIO FLOWSFOR PORTFOLIO FLOWSFOR PORTFOLIO FLOWSFOR PORTFOLIO FLOWS

Prospects for EM portfolio flows hinge crucially on prospects for increases in Fed policy

rates. Since January, expectations for Fed tightening have been pushed backwards,

0

2

4

6

8

10

2010 2012 2014

IIF EM Coincident IndicatorIIF EM Coincident IndicatorIIF EM Coincident IndicatorIIF EM Coincident Indicatorpercent change

SourceSource

EMCI, 3m/3m, saar

Source: IIF.

EM GDP, q/q, saar



Figure 1: Drivers of EM Capital Flows by Major Component Figure 1: Drivers of EM Capital Flows by Major Component Figure 1: Drivers of EM Capital Flows by Major Component Figure 1: Drivers of EM Capital Flows by Major Component

DriverDriverDriverDriver Portfolio EquityPortfolio EquityPortfolio EquityPortfolio Equity Portfolio DebtPortfolio DebtPortfolio DebtPortfolio Debt Banking FlowsBanking FlowsBanking FlowsBanking Flows FDIFDIFDIFDI

Global risk aversion

PushPushPushPush Mature economy interest rates

Mature economy output growth

Domestic output growth

PullPullPullPull Asset return indicators

Country risk indicators

Strong evidence for negative relationship

TypeTypeTypeType

Strong evidence for positive relationship

Some evidence for positive relationship

Mixed evidence, no clear relationship

Some evidence for negative relationship

Source: IIF Working Paper “What Drives Capital Flows to Emerging Markets?”, April 2015.

https://www.iif.com/publication/capital-flows/january-2015-capital-flows-emerging-markets

https://www.iif.com/publication/global-economic-monitor/april-2015-global-economic-monitor

https://www.iif.com/publication/capital-flows/what-drives-capital-flows-emerging-markets-2



reflecting the sluggish U.S. growth performance, even though the U.S. labor market has

continued to heal. While at the beginning of the year, a June 2015 rate hike seemed on

the cards, the first rate hike now seems unlikely to occur before September and then

only if the U.S. economy regains momentum in coming months. In addition, the

expected trajectory of rate increases has become less steep, helped by a downward shift

in the FOMC’s own interest rate projections (Chart 12). On the other side of the Atlantic,

sovereign QE by the ECB has delivered a substantial reduction in European bond yields

and expectations for future ECB policy rates, albeit partly reversed during the first half of

May (Chart 13).

We estimate that lower policy rate expectations in both the U.S. and the Euro Area have

had a positive direct impact on portfolio flows to EMs, in particular this year (Chart 11).

In the past, shifts in perceptions about Fed rates have been the dominant factor, but

ECB actions have risen in importance recently. In addition to this direct effect, lower

European bond yields were one factor weighing on U.S. rates (in part because portfolio

substitution effects coming from the ECB’s QE program drove down the term premium

-1.6

-1.2

-0.8

-0.4

0.0

0.4

0.82015 2016

Forecast Revisions to GDP GrowthForecast Revisions to GDP GrowthForecast Revisions to GDP GrowthForecast Revisions to GDP Growth Relative to January CFRRelative to January CFRRelative to January CFRRelative to January CFRpercentage points

Source: IIF.


-20

-16

-12

-8

-4

0

4

8

12

16

2013 2014 2015

Fed

ECB

Estimated ContributionsEstimated ContributionsEstimated ContributionsEstimated Contributions to EM Portfolio Flowsto EM Portfolio Flowsto EM Portfolio Flowsto EM Portfolio Flows$ billion, cumulative contributions since 1/1/2013

Source: Bloomberg, IIF.

Taper Tantrum

Bund Tantrum


Chart 12Chart 12Chart 12Chart 12 Chart 13Chart 13Chart 13Chart 13

Lower policy rate Lower policy rate Lower policy rate Lower policy rate expectations in expectations in expectations in expectations in both the U.S. and both the U.S. and both the U.S. and both the U.S. and the Euro Area the Euro Area the Euro Area the Euro Area have had a have had a have had a have had a positive direct positive direct positive direct positive direct impact on impact on impact on impact on portfolio flows to portfolio flows to portfolio flows to portfolio flows to EMsEMsEMsEMs

0

1

2

3

Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15

10101010----YearYearYearYear Govt. Bond YieldsGovt. Bond YieldsGovt. Bond YieldsGovt. Bond Yieldspercent

Germany

U.S.

Source: Haver.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2015 2016 2017 2018

Market Expectations as of 5/22/2015

Market Expectations as of 1/8/2015

FOMC as of 12/2014

FOMC as of 3/2015

Outlook for Federal Funds RateOutlook for Federal Funds RateOutlook for Federal Funds RateOutlook for Federal Funds Ratepercent, based on fed fund futures and Eurodollar contracts, FOMC = Median FOMC projection

Source: Bloomberg, Federal Reserve, IIF.



in U.S. bond yields and in part because of the damping impact on the U.S. economy of

the US dollar appreciation against the Euro), supporting portfolio flows to EMs.

Going forward, we project that the Fed will start to tighten in September, and then raise

rates by an average of 25 basis points a quarter through 2016, in line with FOMC

projections and the current economist consensus. Market expectations for Fed rate hikes

would edge gradually higher and closer towards the FOMC’s own projected trajectory

(Chart 12) as the date of liftoff comes closer, assuming that U.S. growth recovers

momentum over the summer months and labor markets continue to tighten. It is

important to note, however, that the assumed Fed policy trajectory in this scenario does

not rely on strong U.S. growth outcomes – we assume quarterly growth rates in the range

of 2.5-3 percent from Q3 onwards—but instead is linked to growing evidence for a

closing output gap and a weakening of the supply side of the U.S. economy. This

weakening has occurred across several dimensions.

One is that U.S. productivity performance has been lackluster in the post-crisis period:

growth in real output per hour has been less than half of the pre-2008 average (Chart

14). In addition, labor force participation rates have failed to pick up from their post-crisis

lows and the matching function of the labor market has deteriorated as illustrated by an

outward shift of the Beveridge curve in recent years (Chart 15). This is likely to reflect

continued problems in the housing market, which weigh on labor mobility as well as

continued skills mismatches.

Under the baseline scenario, the drag on EM portfolio and banking flows from gradually

increasing U.S. interest rates would be offset to some extent by the moderate pickup in

mature economy growth. Nonetheless, the uncertainty surrounding the transition to Fed

liftoff and associated adjustment of market expectations is likely to lead to some volatility

of portfolio flows, notably for those EMs with vulnerable macro fundamentals and policy

frameworks. The beginning of this year gave some flavor of the effects of such an

adjustment in rate expectations as markets brought forward their expected timing of the

first rate hike against the background of strong employment data in the U.S. (only to shift

them back again from mid-March onwards).

-2

-1

0

1

2

3

4

5

6

1990 1995 2000 2005 2010 2015

Period averages

U.S. BusinessU.S. BusinessU.S. BusinessU.S. Business Sector ProductivitySector ProductivitySector ProductivitySector Productivitypercent, oya; real output per hour

Source: Haver, BLS.


1.5

2.0

2.5

3.0

3.5

4.0

4 5 6 7 8 9 10 11unemployment rate, percent of labor force

2008H2

20112012

2009

2010

U.S. Beveridge Curve (2001U.S. Beveridge Curve (2001U.S. Beveridge Curve (2001U.S. Beveridge Curve (2001----2014 Data)2014 Data)2014 Data)2014 Data)job openings rate in percent of total jobs (filled and vacant)

2013

Source: BLS, IIF.

2014

2001-2008H1


We project that We project that We project that We project that the Fed will start the Fed will start the Fed will start the Fed will start to tighten in to tighten in to tighten in to tighten in September, and September, and September, and September, and then raise rates by then raise rates by then raise rates by then raise rates by an average of 25 an average of 25 an average of 25 an average of 25 basis points a basis points a basis points a basis points a quarter through quarter through quarter through quarter through 2016201620162016



WHAT IF REALITY DOES NOT FOLLOW THE BASEWHAT IF REALITY DOES NOT FOLLOW THE BASEWHAT IF REALITY DOES NOT FOLLOW THE BASEWHAT IF REALITY DOES NOT FOLLOW THE BASELINE SCENARIO?LINE SCENARIO?LINE SCENARIO?LINE SCENARIO?

Our baseline scenario is arguably a relatively benign one in current circumstances with a

pick-up in global growth, supporting a recovery of capital flows to EMs. However, after

years of post-crisis disappointments, there are rising doubts about global economic

performance. Here we consider how different scenarios for mature economy GDP growth

and U.S. policy tightening could affect EM growth and capital flows in various ways

(Chart 16).

The best outcome would be robust demand combined with improved supply side

performance and only moderate labor market tightening. This could be seen as a “return

to normal” or “sweetspot” case whereby U.S. growth potential is sufficiently high that

spare capacity is absorbed only slowly despite strong output growth—the best of all

worlds for EM capital flows. Compared to this, our baseline scenario is somewhat more

pessimistic as it combines weaker growth with the same degree of labor market and

policy tightening.

However, there are two alternative scenarios that would have much less benign

implications for EMs. In both cases, capital flows to EMs would remain under pressure,

rather than rebound markedly in 2016 as projected in our baseline scenario.

The first scenario would be a “secular stagnation” scenario, in which mature economy

aggregate demand growth continues to turn out weaker than projected. In these

circumstances, labor market tightening would occur much more gradually and price

inflation would remain well below central bank targets. This could occur as continuing

disappointment with growth outcomes feeds into rising concerns about prospects,

dampening both consumer confidence and business sentiment. This could be reinforced

by a sense that policymakers were running out of instruments to push economies against

strong secular drags, including aging populations, less productivity kick from


FDI Bank Portfolio

Sweetspot

Baseline

Secular Stagnation

U.S. Supply Shock

Note: dark red denotes very adverse impact, dark green denotes

very positive impact.

EM GDP growth

U.S. labor market tightening /Fed policy rate hikes / global risk aversion

Sweetspot

Baseline

Secular Stagnation

EM Capital Flows EM Capital Flows EM Capital Flows EM Capital Flows ---- Different ScenariosDifferent ScenariosDifferent ScenariosDifferent Scenarios

U.S. Wage Shock

EM Capital Flows Scenarios Impact by Type of FlowEM Capital Flows Scenarios Impact by Type of FlowEM Capital Flows Scenarios Impact by Type of FlowEM Capital Flows Scenarios Impact by Type of Flow

We consider how We consider how We consider how We consider how different scenarios different scenarios different scenarios different scenarios for mature for mature for mature for mature economy GDP economy GDP economy GDP economy GDP growth and U.S. growth and U.S. growth and U.S. growth and U.S. policy tightening policy tightening policy tightening policy tightening could affect EM could affect EM could affect EM could affect EM growth and capital growth and capital growth and capital growth and capital flows flows flows flows



technological progress, and slower convergence by EMs. This would lead the Fed to

signal that it will wait longer to start liftoff (thus more or less validating current market

rate expectations) and then raise rates very gradually with the end-point for rate

increases lower as expectations for longer term growth and equilibrium real rates come

down.

The lower trajectory for Fed rates would benefit portfolio flows thanks to lower global

interest rates than otherwise. However, EM growth would also turn out weaker due to

less demand from mature economies, which would weigh on capital flows, notably FDI.

Overall, we would expect capital flows to EMs to be stagnant in this scenario.

The second scenario—arguably an even more negative one from an EM perspective—

would be a negative U.S. wage shock, whereby even with U.S. demand growing only

moderately according to our baseline, wage pressures pick up more rapidly than

envisaged. This could be the case if the U.S. labor market supply response to rising labor

demand remains weak, implying that even meagre aggregate demand growth leads to a

pick-up in wage pressures. In this case, the Fed would tighten policy quicker than even

their own current projections suggest and market expectations could adjust quite

abruptly, triggering a “super taper tantrum.” Such an adjustment would likely be

accompanied by rising risk aversion.

For EM capital flows, this would be the worst of all worlds with higher global interest

rates, less favorable financing conditions and lackluster mature economy growth.

Movements in EM asset prices could be quite sharp, exacerbated by reduced market

liquidity. In such circumstances, the broad EM asset class could be affected by wide

outflows that would be less differentiated, as liquid markets could suffer quite heavy

withdrawals, at least until market stress subsides. Overall, EM flows could be substantially

lower, mainly because of weaker portfolio flows.


0

10

20

30

40

50

60

70

0

1

2

3

4

5

6

7

8

9

2000 2002 2004 2006 2008 2010 2012 2014

U.S. BBBU.S. BBBU.S. BBBU.S. BBB----Rated Corporate Bond Spread and VIXRated Corporate Bond Spread and VIXRated Corporate Bond Spread and VIXRated Corporate Bond Spread and VIXpercent per annum

Source: Bank of America/ Merrill Lynch, CBOE.

U.S. Corp BBB Spread

VIX


0.1

0.2

0.3

0.4

0.5

0.6

0.7

2008 2009 2010 2011 2012 2013 2014 2015

Pre-2008Crisis Average

Post-2008Crisis Average

Source: IIF, Bloomberg.

Correlation Across EM ExchangeCorrelation Across EM ExchangeCorrelation Across EM ExchangeCorrelation Across EM Exchange RatesRatesRatesRatesaverage 30-day rolling correlation between percentage change in MSCI EM FX index and USD/LC exchange rate for 22 EMs

A U.S. wage shock A U.S. wage shock A U.S. wage shock A U.S. wage shock would be the would be the would be the would be the worst scenario for worst scenario for worst scenario for worst scenario for EM capital flows.EM capital flows.EM capital flows.EM capital flows.



WHO’S AT RISK FROM A SPIKE IN GLOBAL RISWHO’S AT RISK FROM A SPIKE IN GLOBAL RISWHO’S AT RISK FROM A SPIKE IN GLOBAL RISWHO’S AT RISK FROM A SPIKE IN GLOBAL RISK AVERSION K AVERSION K AVERSION K AVERSION

If history is any guide, global risk aversion would increase sharply, at least temporarily,

under a scenario in which market expectations for Fed policy shift abruptly. Recently,

most broad measures of global risk aversion have remained at relatively low levels, at

least when compared to historical averages (Chart 17). An increase in global risk aversion

would likely introduce additional volatility into capital flows to EMs. A structural decline

in market liquidity increases the degree of concern with volatility spikes (see pages 20-

24).

Not all EMs would be hit equally. In fact, markets have continued to differentiate

significantly across EMs, with cross-country correlations for different asset markets

remaining significantly lower than in the years prior to 2013 (Chart 18). To calibrate the

impact of risk shocks across EMs, we have estimated risk responsiveness betas for some

major EMs, which again supports the differentiation story (see Box).

Our IIF Heatmap of EM vulnerabilities attempts to compare macro fundamentals across

EMs. The country ranking identified in the Heatmap correlates well with market

performance across EMs (Chart 19; see also the discussion in our April Global Economic

Monitor). Much of the focus ever since the 2013 taper tantrum has been on external

vulnerabilities and more recently on policy vulnerabilities. Specifically, EMs with large

current account deficits, such as South Africa, Turkey and Brazil, have tended to

underperform. By contrast, India has used the time since the taper tantrum to reduce its

current account deficit and has been more resilient to market pressures in recent months.

The sharp decline in oil prices relative to its highs in early 2014, notwithstanding the

recent rebound, has tended to reduce external vulnerabilities of oil importers, but hurt oil

exporters. India, for example, clearly is a beneficiary and also took advantage of lower oil

prices to reduce fuel subsidies. While Turkey benefits from a lower oil import bill, much

BR

CLCN

CO

HU

IN

ID

MY

MX

PE

PH

PLRO

ZA

TRRU

-40

-20

0

20

40

60

80

100

0.3 0.4 0.5 0.6 0.7

average of domestic, external and policy vulnerability indices*

*A higher value implies higher vulnerability and vice-versa. Source: IIF, Bloomberg.

IIF Heat MapIIF Heat MapIIF Heat MapIIF Heat Map Vulnerability Measures Vulnerability Measures Vulnerability Measures Vulnerability Measures vs. EMBIG Spreadsvs. EMBIG Spreadsvs. EMBIG Spreadsvs. EMBIG Spreads

change in EMBIG spreads since Aug 2014


AnAnAnAn increase in increase in increase in increase in global risk global risk global risk global risk aversion would aversion would aversion would aversion would likely introduce likely introduce likely introduce likely introduce additional additional additional additional volatility into volatility into volatility into volatility into capital flows to capital flows to capital flows to capital flows to EMsEMsEMsEMs

https://www.iif.com/publication/heat-map-em-vulnerabilities

https://www.iif.com/publication/global-economic-monitor/april-2015-global-economic-monitor




BOX: CALIBRATING THEBOX: CALIBRATING THEBOX: CALIBRATING THEBOX: CALIBRATING THE IMPACT OF A RISK SHIMPACT OF A RISK SHIMPACT OF A RISK SHIMPACT OF A RISK SHOCKOCKOCKOCK

A bumpy Fed exit could prompt a spike in global risk

aversion that would spill over into emerging markets. In a

recent research note, we estimate how responsive various

emerging markets’ asset prices are to changes in global risk

aversion. We refer to this relationship as the “EM risk beta,”

analogous to the relation between individual stock prices

and the overall stock market in the Capital Asset Pricing

Model (CAPM) framework. We cover 10 major EM

economies during the period from 2000–2015, and focus on

the MSCI EM stock market index and the U.S. corporate BBB

spread, which have been strongly correlated in recent years

(Chart 20). In addition, we consider other EM asset price

variables like EM bond spreads over U.S. Treasuries and the

exchange rate vis-à-vis the U.S. dollar. We also cross-check

our results by using an alternative measure of global risk

aversion (the VIX).

A useful estimate of the responsiveness of EM stocks to

changes in risk aversion can be obtained by running a simple

regression of the daily percent change in the MSCI EM on

the daily percent change in the BBB spread, plus a constant

term: %EM Asset Pricest = c + β * %BBBt

The coefficient β provides a measure of the elasticity of the

response to shifts in global risk aversion. Within the last 15

years, we look at three sample periods—the pre-crisis period

(2000-2007), the crisis years (2008-2009), and the most

recent years (2012-2015). It is notable that the estimated risk

betas have increased since as EMs have become more

interconnected with global markets (Chart 21).

Countries with high risk betas tend to be those that score

highly on two dimensions: greater vulnerability according to

our EM heat map, and greater openness. On the

vulnerability scale, external financing requirements as

measured by current account deficits shows a particularly

close relationship (Chart 22).

Aside from country vulnerabilities, higher risk betas may also

reflect greater openness, making countries more responsive

to changes in global investor sentiment. A related factor is

the degree to which domestic securities are owned by

foreign investors. We find that risk betas tend to be higher

when foreign investors own a sizeable share of a country’s

securities.

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

0 1 2 3 4

Current Account Balance

Risk Betas EstimatedRisk Betas EstimatedRisk Betas EstimatedRisk Betas Estimated Using Bond Spreads Using Bond Spreads Using Bond Spreads Using Bond Spreads vs. CAvs. CAvs. CAvs. CA BalanceBalanceBalanceBalancepercent of GDP, IIF forecast for 2015 current account balance

Estimated % Response to 1% Increase in Global Risk Aversion

TurkeySouth Africa

China

BrazilIndonesia

PolandMexico

IndiaChile

Source: Bloomberg, IMF, IIF.



-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

India

Poland

Indonesia

South Africa

China

Chile

Turkey

Mexico

Brazil

Russia

2000-2007

2008-2009

2012-2015

EM Risk Betas Estimated Using EM MSCI and U.S. EM Risk Betas Estimated Using EM MSCI and U.S. EM Risk Betas Estimated Using EM MSCI and U.S. EM Risk Betas Estimated Using EM MSCI and U.S. BBB SpreadBBB SpreadBBB SpreadBBB Spreadestimated % response to 1% increase in global risk aversion


1.0

1.5

2.0

2.5

3.0

3.5800

900

1,000

1,100

1,200

2010 2011 2012 2013 2014 2015

MSCI EM and U.S. Corporate BBB SpreadMSCI EM and U.S. Corporate BBB SpreadMSCI EM and U.S. Corporate BBB SpreadMSCI EM and U.S. Corporate BBB Spreadindex percentage points

BBB Spread

MSCI EM


https://www.iif.com/publication/html-publication/which-ems-would-suffer-risk-shock



of the benefit for growth has been eaten up by the fall in the lira. Oil exporters in general

have suffered, seeing a worsening of their external positions and reductions in

government spending weighing on growth, raising particular concerns for countries like

Venezuela with weak macropolicy frameworks.

On the policy side, vulnerabilities are larger for EMs where central banks do not have

firmly established inflation targeting credentials, as reflected in inflation expectations

consistently above target. Turkey is one example of an EM that has lost ground in terms

of monetary policy credibility, as it cut policy rates even as inflation expectations remain

elevated. By contrast, India has benefitted from steps to strengthen its monetary policy

framework.

Going forward, we expect differentiation to focus increasingly on domestic

vulnerabilities, such as credit growth and debt burdens, not least because rising U.S.

policy rates will make refinancing this debt more challenging, in particular when coupled

with further dollar appreciation (see pages 15-19). EMs where corporate debt has risen

sharply, including a significant share in USD-denominated debt include Brazil, Hungary,

Mexico, Russia, and Turkey.

Overall, and based on external, policy and domestic vulnerabilities, EMs that we remain

most concerned in the event of a sharp rise in global risk aversion include Brazil,

Indonesia, Russia, South Africa and Turkey.

On the policy side, On the policy side, On the policy side, On the policy side, vulnerabilities are vulnerabilities are vulnerabilities are vulnerabilities are larger for EMs larger for EMs larger for EMs larger for EMs where central where central where central where central banks do not have banks do not have banks do not have banks do not have firmly established firmly established firmly established firmly established inflation targeting inflation targeting inflation targeting inflation targeting credentials. credentials. credentials. credentials.



THE GREAT EM RESERVE SLOWDOWN THE GREAT EM RESERVE SLOWDOWN THE GREAT EM RESERVE SLOWDOWN THE GREAT EM RESERVE SLOWDOWN

EM reserve accumulation has moderated substantially since the global financial crisis, and

in 2014 slowed to the weakest pace since 2001 amidst weaker non-resident capital

inflows and higher private resident outflows (Chart 23). Moreover, overall EM current

account balance eased slightly, as a decrease in the current accounts of oil exporters

offset the increase in the current accounts of oil importers (Chart 24). Due to these two

factors, oil exporters’ FX reserves declined and oil importers’ reserve growth halved.

Most dramatically, FX reserves plunged in EM Europe for a second year (Chart 25). The

decline was largely driven by Russia, where non-resident capital inflows declined

significantly in the context of uncertainty associated with the Ukraine conflict. Unfavorable

non-resident capital inflow and private resident capital outflow dynamics also reduced

reserves in Ukraine, Turkey and Romania and slowed reserve accumulation in Hungary

and Poland. However, current account balances improved in most countries, including in

Russia (as lower oil exports were accompanied by demand compression) and Turkey.

In EM Asia, reserve accumulation was cut in half led by weaker capital flows even as

current account balances improved. The key driver was China, where reserve

accumulation slowed significantly amidst the largest private resident outflows since at

least 1983, causing the central bank to intervene towards the end of the year in order to

contain RMB depreciation. Non-resident capital inflows moderated as well as the Chinese

economy slowed. FX reserves declined in Thailand and oil-exporter Malaysia—where

increased risk aversion halved non-resident capital inflows from 2013—and in Philippines

where private resident outflows jumped.

The marked deceleration in reserve growth in Middle East & Africa was driven by

narrowing trade and current account surpluses among oil exporters Saudi Arabia, UAE

and Nigeria. Nigeria also witnessed weaker capital inflows. Reserve accumulation in

South Africa continued to slow rapidly amidst private resident outflows, even though

current account balance and non-resident capital inflows picked up from 2013.

-1200

-800

-400

0

400

800

1200

1600

2000

2000 2002 2004 2006 2008 2010 2012 2014 2016

Resident Private Outflows

Non-Resident Inflows

Current Account Balance

Reserve Accumulation

Source: IIF.

Drivers of EM Reserve AccumulationDrivers of EM Reserve AccumulationDrivers of EM Reserve AccumulationDrivers of EM Reserve Accumulation$ billion

IIF Forecast


-200

0

200

400

600

800

1,000

1,200

2000 2002 2004 2006 2008 2010 2012 2014 2016

EM Asia

Middle East/Africa

Latin America

EM Europe

EM

EM FX Reserve Accumulation by RegionEM FX Reserve Accumulation by RegionEM FX Reserve Accumulation by RegionEM FX Reserve Accumulation by Region$ billion

Source: IIF.

IIF Forecast


-200

-100

0

100

200

300

400

500

600

2003 2009 2015

Oil Importers

Oil Exporters

Source: IIF.

IIF Forecast

EM Current Account BalanceEM Current Account BalanceEM Current Account BalanceEM Current Account Balance$ billion


EM reserve EM reserve EM reserve EM reserve accumulation has accumulation has accumulation has accumulation has moderated moderated moderated moderated substantially since substantially since substantially since substantially since the global financial the global financial the global financial the global financial crisis.crisis.crisis.crisis.



By contrast, Latin America witnessed an increase in FX reserves following a drop in 2013

led by Brazil, Argentina and Venezuela as a deterioration in current account balances was

financed by higher capital inflows and/or reduced private resident outflows.

Looking ahead, we expect EM reserve accumulation to slow further in 2015. Current

account balances are projected to weaken in aggregate, as a decline in oil exporters’

current accounts will more than offset an improvement in oil importers’ current accounts.

Non-resident capital inflows are likely to moderate among most oil exporters as well as in

over half of oil importers. Overall, we expect oil exporters’ FX reserves to decline in

aggregate and to be only marginally offset by an improvement in oil importers’ FX

reserves (Chart 26).

In fact, monthly FX reserves data adjusted for valuation changes indicate a decline in EM

FX reserves in 2015Q1, in line with our projections for a decline in reserves this year in

countries like Saudi Arabia, Malaysia, Russia, South Africa and Nigeria and weaker reserve

accumulation in China but a further pick up in reserve accumulation in countries like Korea

(Chart 27). Data for Venezuela’s reserves have not been published, but are estimated to

have declined further.

In this environment, a number of countries with a low reserve coverage ratio based on FX

reserve holdings at the end of 2014 and large external financing needs for 2015 will be

vulnerable to periods of stress since the central bank’s ability to intervene to limit currency

depreciation will be constrained (Chart 28). Many of these countries are expected to

witness a decline in FX reserves (Venezuela, Argentina, Lebanon, Malaysia and South

Africa) or a slowdown in non-resident inflows (Indonesia, Malaysia, South Africa, Turkey,

Lebanon and Ecuador) during 2015. Countries like Argentina, Turkey and Czech Republic

also received large portfolio equity and debt inflows during 2009-13 relative to their FX

reserve holdings, thus making them susceptible to risk shocks. South Africa, Indonesia and

Turkey have been on our watch list for a while.


ARPLBG

ZA

BR

MY

RO

RU

CO

KR

LB

MO

ID

CL

HU

PEPH

CZ

MX

IN

NG(9.1, 1.7)

TH

TR

VEUKEC

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

reserve coverage ratio in 2008*

CN(5.9, 5.1)

EG

EM Reserve AdequacyEM Reserve AdequacyEM Reserve AdequacyEM Reserve Adequacyreserve coverage ratio in 2015* (threshold=1.0)

FX reserves at end of previous year/(Current account deficit + short-term external debt + amortization payments due in current year). Source: IIF.


-200

0

200

400

600

800

1,000

1,200

2003 2009 2015

Oil ImportersOil Exporters

Source: IIF.

IIF Forecast

EM FX ReservesEM FX ReservesEM FX ReservesEM FX Reserves$ billion


-50

-40

-30

-20

-10

0

10

20

30

40

CN SARU

MY

NG

RO ZA

MO PECL

CO TR

AR

EG ID CZ

TH

BG

HU

UK

PH PL

LB BR

MX

KO IN

Valuation AdjustedValuation AdjustedValuation AdjustedValuation Adjusted Change in EM FX Reserves in 2015Q1Change in EM FX Reserves in 2015Q1Change in EM FX Reserves in 2015Q1Change in EM FX Reserves in 2015Q1$ billion

Source: IMF IFS, IIF Calculations.

We expect EM We expect EM We expect EM We expect EM reserve reserve reserve reserve accumulation to accumulation to accumulation to accumulation to slow further in slow further in slow further in slow further in 2015. 2015. 2015. 2015.



EMERGING MARKET CORPORATE DEBTEMERGING MARKET CORPORATE DEBTEMERGING MARKET CORPORATE DEBTEMERGING MARKET CORPORATE DEBT————WHERE ARE THE RISKS? WHERE ARE THE RISKS? WHERE ARE THE RISKS? WHERE ARE THE RISKS?

A striking phenomenon in recent years has been the speed of growth in EM corporate bond

markets. This growth has been driven both by the hunt for yield as global investors look

further afield, and by the ongoing development of EM bond markets more broadly. Since

2008, total corporate bonds outstanding have almost doubled, surpassing $6.8 trillion at end

-2014, significantly outpacing the growth of bank credit. While both financial and non-

financial corporate bonds have contributed to this sharp increase, the rise has been more

pronounced in the EM non-financial corporate bond market, which now totals more than $2.6

trillion—almost triple its level in 2008 (Chart 29).1 With hard currency (mainly USD) corporate

issuance at or near record levels in 2013-14 (Charts 30 and 31), total EM international (hard

currency) debt securities outstanding now total over $1.8 trillion, i.e. one fourth of the total.

Of this, some $520 billion is non-financial corporate, $575 billion is financial corporate, and

about $750 billion is government bonds.

As a result of this rapid growth, outstanding debt of the emerging market non-financial

corporate sector is now over 80% of GDP on average, up from about 60% in 2008; China,

Singapore and Hungary now have corporate debt well over 80% of GDP. A significant part of

this debt has been denominated in foreign currencies, about 25-30% in USD, prompting

concerns about vulnerabilities in many EM countries given recent dollar strength and

widespread anticipation of higher U.S. rates. Many EM firms have “natural hedges,” i.e. dollar

revenue streams, or may have hedged their USD exposure in derivatives markets. However,

those that have limited or no protection against currency risk are likely to face a higher

degree of credit and refinancing risk over the next few years.

Shift towards more bond marketShift towards more bond marketShift towards more bond marketShift towards more bond market----based borrowingbased borrowingbased borrowingbased borrowing

Strong growth in EM bond markets has contributed to a notable shift towards non-financial

corporate financing in most emerging market countries. For example, the share of bond

financing in total non-financial corporate debt financing has increased more than 20

percentage points in Korea and Mexico. Other countries, including Hungary, South Africa,

Indonesia, and Brazil have also witnessed a marked shift towards bond financing (Chart 32).


Our thanks to Elif Aksoy for insights and contributions to this section based on her work on EM corporate debt markets.

1 The BIS statistics by residence of issuer underestimate the size of the EM non-financial corporate sector, as they don’t include issuance via overseas

and offshore subsidiaries—this is particularly true for Brazilian, Chinese and Russian corporates.

0

25

50

75

100

125

2007 2011 2015

Non-fin

Fin

USDUSDUSDUSD Bond IssuanceBond IssuanceBond IssuanceBond Issuance$ billion

Source: Thomson One, IIF.

15

20

25

30

35

40

45

0

100

200

300

400

500

600

700

800

2007 2009 2011 2013 2015ytd

Other foreign currencyEURUSDLocal currencyShare of FC (rhs)

EMEMEMEM Corporates: Bond Issuance, by CurrencyCorporates: Bond Issuance, by CurrencyCorporates: Bond Issuance, by CurrencyCorporates: Bond Issuance, by Currency$ billion

Source: Thomson One, IIF. Data contain financial and non-financial EM30 corporate bond issuances

0 2 4 6

Fin. Corp. LC

Fin. Corp. HC

Non-fin. Corp. HC

Non-fin. Corp. LC

Sov HC

Sov LC

2014

2007

EM Corporate and Sovereign BondEM Corporate and Sovereign BondEM Corporate and Sovereign BondEM Corporate and Sovereign Bond MarketsMarketsMarketsMarkets$ trillion

Source: BIS, IIF.


https://www.iif.com/publication/html-publication/corporate-debt-emerging-markets-what-should-we-be-worried-about



While the majority of this bond financing has been in local currency (65-75%) over the past

few years) , the share of the issuance in foreign currency was over 50% in the first five

months of 2015— a fresh record high (Chart 33). While a shift toward more bond market

financing is part of the structural development of EM capital markets—as such a welcome

development—the speed of the increase in non-financial corporate debt in some

emerging markets is a cause for concern.

CrossCrossCrossCross----border bank lending also rose sharply in 2008border bank lending also rose sharply in 2008border bank lending also rose sharply in 2008border bank lending also rose sharply in 2008----13131313

While the focus has been on the rise in bonded debt, growth in cross-border bank lending

to the corporate sector has also been strong in recent years. Indeed, data on BIS-

reporting banks’ international claims on the EM non-bank private sector suggest a

sustained pickup in cross-border bank lending in the aftermath of the 2008 crisis to nearly

$3 trillion in 2014 (Chart 34), driven mainly by non-EU banks—notably, U.S., Japan, and

China. While almost all countries in our sample have increased reliance on cross-border

bank credit, firms in EM Asia and in oil-exporting countries have recorded the largest

buildup in cross-border banking liabilities.

Although some 8-9% of the outstanding stock of international EM loans is denominated in

euro (and would thus be less exposed to a strengthening USD), most of the remainder—

nearly $3 trillion—is USD-denominated.2 While the share of EUR-denominated bank

lending has been broadly stable—and Japanese and Chinese banks are becoming

increasingly important as a source of cross-border credit, primarily in yen and RMB—over

45% of new cross-border lending to EM borrowers was denominated in USD in 2013-14.

A closer look at the USD exposure of EM nonA closer look at the USD exposure of EM nonA closer look at the USD exposure of EM nonA closer look at the USD exposure of EM non----financial firmsfinancial firmsfinancial firmsfinancial firms

To identify specific countries and sectors that would be particularly vulnerable to a

stronger USD and higher U.S. rates, it is worth looking more closely at both the stock of

EM non-financial corporate debt relative to GDP, and at its breakdown by currency and

sector. China is the clearly the elephant in the room—non-financial corporate debt has

grown by more than 50 percentage points since 2008 to around 150% of GDP. However,


2 The series on the currency decomposition of the cross-border bank lending is based on Bloomberg data.


0

10

20

30

40

50

2007 2011 2015

NonNonNonNon----Fin.Fin.Fin.Fin. Corporate Bond Corporate Bond Corporate Bond Corporate Bond Issuance in Foreign Currency Issuance in Foreign Currency Issuance in Foreign Currency Issuance in Foreign Currency percent

Share of USD

Share of EUR

Source: Thomsone One, IIF.

0 10 20 30 40 50

Turkey

Hungary

China

Indonesia

Russia

Brazil

Thailand

South Africa

Korea

Mexico

2014

2008

ShareShareShareShare of Bond Financing for EM Nonof Bond Financing for EM Nonof Bond Financing for EM Nonof Bond Financing for EM Non----financial Corporatesfinancial Corporatesfinancial Corporatesfinancial Corporatespercentage of total debt financing

Source: BIS, IIF.

0.0

0.8

1.6

2.4

3.2

1996 1999 2002 2005 2008 2011 2014

Government

Banks

Nonbank Private Sector

International Claims of BIS reporting Banks in EM30International Claims of BIS reporting Banks in EM30International Claims of BIS reporting Banks in EM30International Claims of BIS reporting Banks in EM30$ trillion

Source: BIS-CBS, IIF.



other EM countries have also seen a notable increase in non-financial corporate sector

indebtedness, including Turkey, Brazil, and Russia (Charts 35). While a number of

countries, notably Korea, China and Russia, now have less USD exposure relative to GDP

than in 2008 (in some cases due to deliberate efforts to reduce such exposure), for many

EM countries USD exposure continues to be a significant proportion of overall debt

(except in a number of Central and East European countries, where euro-denominated

borrowing has been more prevalent). Across the emerging market countries in our

sample, USD borrowing exposure of the non-financial corporate sector stands at over

10% of GDP on average (Chart 36).3

Which emerging marketsWhich emerging marketsWhich emerging marketsWhich emerging markets————and sectorsand sectorsand sectorsand sectors————are most at risk from USD liabilities?are most at risk from USD liabilities?are most at risk from USD liabilities?are most at risk from USD liabilities?

In an environment of rising global interest rates, Fed tightening, EM currency

depreciation (Chart 37) and slowing economic growth and capital flows, USD-

denominated debt may become increasingly difficult for EM non-financial corporate

borrowers to repay. Some of these firms also suffer from significant reduction in oil and

commodity prices as well as a general slowdown in growth of global trade. Indeed, for

EM-30 countries, maturing USD non-financial corporate bonds and cross-border loans

total around $375 billion for the 2016-18 period (Chart 38)—a period when U.S. rates are

likely to be higher, making roll-over of credits more difficult. Against this backdrop, a key

question is how well EM corporates are hedged against potential currency mismatches

during stress episodes.

To identify vulnerabilities for specific countries and sectors, it is helpful to look both at

the stock of EM non-financial corporate debt relative to GDP, and at its breakdown by

currency and sector. Looking at specific sectors, a key question is to what extent

currency risk may be hedged—either via a natural hedge such as export revenues, or via

derivatives markets. Some corporate borrowers may also maintain significant foreign

currency assets on their balance sheets to offer a degree of protection for FX liabilities.





-10 0 10 20 30 40 50 60

South AfricaKorea

Saudi ArabiaIndia

ThailandMexicoPoland

HungaryCzech Rep.Indonesia

RussiaBrazilTurkeyChina

ChangeChangeChangeChange in EM Nonin EM Nonin EM Nonin EM Non----Financial Corporate DebtFinancial Corporate DebtFinancial Corporate DebtFinancial Corporate Debt----totototo----GDP RatioGDP RatioGDP RatioGDP Ratio

percentage point change since 2008

Source: BIS, IIF.

3 Underlying data in Chart 8 cover international and domestic debt securities as well as domestic and cross-border bank credit provided by the BIS.

Data on currency breakdown is based on IIF estimates.

95

100

105

110

115

120

125

130

135

2013 2014 2015

USD vs DM

USD vs EM

U.S. DollarU.S. DollarU.S. DollarU.S. Dollar

index, end-2012=100

U

USD Appreciates


020406080100120140160

2015 2018 2021

USD Loans

USD Bonds

EMEMEMEM----30303030 USD denominated USD denominated USD denominated USD denominated Debt Maturity ProfileDebt Maturity ProfileDebt Maturity ProfileDebt Maturity Profile$ billions


0 20 40 60 80 100 120 140 160

Indonesia

Mexico

South Africa

Brazil

Turkey

Thailand

Russia

Hungary

Korea

China

LC

USD

Others

EMEMEMEM NonNonNonNon----Financial Corporate Debt in 2014Financial Corporate Debt in 2014Financial Corporate Debt in 2014Financial Corporate Debt in 2014percent of GDP

Source: BIS, IIF estimates.



Looking across the diverse range of EM countries and taking into account both the level of

corporate external debt and the structure of the economy, the impact of a stronger U.S. dollar is

likely to vary considerably:

■ More protected: More protected: More protected: More protected: commodity producers and exporters of manufactured goods typically have

a natural hedge as their revenues are primarily USD-denominated. Within the internationally

tradable EM corporate bond universe, these sectors (energy and basic metals) account for

around 30% of total outstanding bonds (Chart 39). However, it is important to note that

many such “hedged” EM corporates—oil and commodity producers in particular—have

seen prices of their exports fall substantially over the past year, reducing the value of their

natural hedges.

■ Indirect exposureIndirect exposureIndirect exposureIndirect exposure: Financial corporates are typically adequately hedged against currency

risk via derivatives markets, mainly due to regulatory requirements that limit the extent to

which banks can have currency mismatches. However, as some non-financial corporates are

not hedged against this risk, their FX risk may translate into credit risk for banks at times of

market stress. For example, Turkish banks have relatively small net open foreign currency

positions (around 3% of bank capital). However, the Turkish non-financial corporate sector

has FX liabilities of over $250 billion, and over $140 billion of this accounts for domestic FX

loans.

■ Little direct impactLittle direct impactLittle direct impactLittle direct impact: For others, a rising U.S. dollar may have little impact. Countries with

managed and pegged currencies, like China, Hong Kong and GCC, would be better

protected from higher debt service costs due to currency depreciation (Chart 40), though

rising global rates would affect their refinancing costs. The flip side, however, is that where

a currency peg proves to be unsustainable, corporates may be exposed to a sharp and

unexpected rise in their foreign currency liabilities in local currency terms when its peg

breaks down.

■ Limited vulnerabilityLimited vulnerabilityLimited vulnerabilityLimited vulnerability: Some countries/sectors face fewer risks, either because corporate

USD exposure is modest, and/or because there is some degree of hedging in place.

Although reliable data on hedging activities are limited, corporate sectors in countries such

as Mexico and Korea have relatively better access to more liquid domestic and offshore

markets, which can help in hedging currency mismatches. However, hedging markets in


Others -22.4%

CA Surplus Countries- 25.6%

South Africa, Turkey, Indonesia, India & Brazil -23.2%

Russia -10.4%

China - 10%

Hong Kong -8.5%

EMEMEMEM Corporate Bond Corporate Bond Corporate Bond Corporate Bond ---- Country BreakdownCountry BreakdownCountry BreakdownCountry Breakdown

Source: Market Vectors, IIF.

GCC -12.8%

Financials -40%

Energy - 22%

Utilities -8.3%

Communications - 8.1%

Basic Materials-7.6%

Consumer -6.4% Other -

7.6%

Source: Market Vectors, IIF.

EMEMEMEM Corporate Bond Corporate Bond Corporate Bond Corporate Bond ---- Industry BreakdownIndustry BreakdownIndustry BreakdownIndustry Breakdown

The impact of a The impact of a The impact of a The impact of a stronger U.S. stronger U.S. stronger U.S. stronger U.S. dollar is likely to dollar is likely to dollar is likely to dollar is likely to vary considerably.vary considerably.vary considerably.vary considerably.



most EMs are not well developed, with high associated costs continuing to

discourage many firms from hedging FX risk. As noted by the BIS, one big issue is

the lack of liquidity in hedging markets, particularly in times of stress. Given that

exposures are typically hedged with more liquid short-term contracts in an attempt

to reduce hedging costs, it becomes harder to roll over these contracts as swap

dealers become less willing to sell protection (as seen during the 2013 taper

tantrum and the oil price shock of H2 2014). In some countries, like Brazil, central

banks with ample reserves may step in to provide currency hedges to corporates at

times of stress. However, the expectation of such behavior can also serve to

discourage development of private hedging markets.

■ Higher riskHigher riskHigher riskHigher risk: Specific sectors in some countries are at higher risk due to high levels of

USD exposure and/or a lack of natural hedges and access to derivatives markets. In

particular, firms in the consumer and real estate sectors with local currency revenues

and FX expenses seem to be more exposed to currency risks. This may pose

particular problems for these sectors in countries with economic/political

vulnerabilities (see pages 10-12).

Against this backdrop, with EM corporate issuers facing a diverse set of risks, careful

attention to credit selection is warranted by investors. While broad valuation measures

(e.g., EMBIG spreads) continue to look attractive relative to those in comparable asset

classes (and relative to their long-run averages), bottom-up analysis of currency and

refinancing risks will be increasingly important in an environment of rising U.S. rates.

One big issue is One big issue is One big issue is One big issue is the lack of the lack of the lack of the lack of liquidity in liquidity in liquidity in liquidity in hedging markets, hedging markets, hedging markets, hedging markets, particularly in particularly in particularly in particularly in times of stress. times of stress. times of stress. times of stress.

http://www.bis.org/publ/qtrpdf/r_qt1409f.htm



SECONDARY MARKET LIQSECONDARY MARKET LIQSECONDARY MARKET LIQSECONDARY MARKET LIQUIDITY IN EMERGING MARKETSUIDITY IN EMERGING MARKETSUIDITY IN EMERGING MARKETSUIDITY IN EMERGING MARKETS————HOW BAD IS ITHOW BAD IS ITHOW BAD IS ITHOW BAD IS IT? ? ? ?

The landscape of portfolio debt investment in emerging markets has evolved

considerably since the 2008 global crisis. The EM debt universe has more than doubled

from $6.5 trillion in 2007 to $13.5 trillion in 2014, supported by robust appetite for EM

debt securities related to the hunt for yield in a low-rate environment (Chart 41).1 Another

contributing factor has been the rapid pace of market development in recent years,

including development of local currency bond markets and capital markets infrastructure

more broadly. However, this robust expansion has also been associated with new

vulnerabilities, including a rapid rise in non-financial corporate indebtedness (see

previous section) and an increasing concern about the lack of liquidity, as market-making

capacity has not kept pace with growth in market capitalization.

Although secondary bond market liquidity more broadly has been under periodic

scrutiny since the onset of the 2008 crisis, the full extent of liquidity risk in EM bond

markets was not on most radar screens until the 2013 taper tantrum. The sharp

retrenchment in foreign portfolio flows into EM debt markets during the summer of 2013

was associated with a surge in EM asset price volatility and a decline in liquidity (Charts

42 and 43).

Notional trading activity in EM debt markets remains below pre-crisis levels (Chart 43)

and has lagged the growth in market capitalization. Hard currency sovereign bond

turnover ratio has more than halved since the crisis (Chart 45). Moreover, trading

volumes in both local currency and corporate debt markets have failed to keep pace with

the surge in bond issuance in recent years and turnover in these two markets is only

around 50% and 25% of the turnover in hard-currency sovereign bonds, respectively.

Available data suggest that the decline in sovereign turnover ratios has been widespread

across a range of both mature and emerging markets, but has been more pronounced in

emerging markets. Brazil and Hong Kong have recorded the largest drop among the

0

2

4

6

8

10

12

14

1998 2002 2006 2010 2014

Hard Currency Corporate

Local Currency Corporate

Hard Currency Sovereign

Local Currency Sovereign

EmergingEmergingEmergingEmerging Market Debt MarketsMarket Debt MarketsMarket Debt MarketsMarket Debt Markets$ trillion

Source: BIS, IIF.


2

4

6

8

10

12

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2012 2013 2014 2015

Fund Flows

Volatility of yields*

EM Local Currency Bond Fund Flows EM Local Currency Bond Fund Flows EM Local Currency Bond Fund Flows EM Local Currency Bond Fund Flows $ billion percent, 180-days volatility

Source: Bloomberg, EPFR, IIF; *Volatilty of CEMBI yields


1. Our sample includes Argentina, Brazil, China, Taiwan (China), Chile, Colombia, Croatia, Czech Republic, Hungary, India, Indonesia, Israel,

South Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Russia, Saudi Arabia, South Africa, Thailand, and Turkey.

3.5

5.0

6.5

8.0

May 12 Nov 13 May 15

BidBidBidBid----Ask Spreads for EM Ask Spreads for EM Ask Spreads for EM Ask Spreads for EM Local Currency Gov't BondsLocal Currency Gov't BondsLocal Currency Gov't BondsLocal Currency Gov't Bondsbps, 10-yr bonds



1

2

3

4

5

6

7

2002 2006 2010 2014

HC corp. HC gov't.LC bonds

Source: EMTA, IIF.

EEEEM Bond Trading Volumes M Bond Trading Volumes M Bond Trading Volumes M Bond Trading Volumes $ trillion, annual


https://www.iif.com/publication/html-publication/corporate-debt-emerging-markets-what-should-we-be-worried-about



MX

BR

JP

HK KR

MY

THID

CN

US IG

US HY

1

2

3

4

5

1 2 3 4 5

Corporate Bonds: Turnover Ratios in 2007 vs 2014Corporate Bonds: Turnover Ratios in 2007 vs 2014Corporate Bonds: Turnover Ratios in 2007 vs 2014Corporate Bonds: Turnover Ratios in 2007 vs 2014log of turnover ratio

Source: FINRA, ABO, BIS, IIF.

2014

2007Lower liquidity

CLCN

HU

IN

ID

KR

ML

PA

PEPH

ZATW

THBR

0

2

4

6

8

10

12

14

0 2 4 6 8 10 12 14

BidBidBidBid----AskAskAskAsk Spreads for EM 10Spreads for EM 10Spreads for EM 10Spreads for EM 10----yr Local Currency Gov't Bondsyr Local Currency Gov't Bondsyr Local Currency Gov't Bondsyr Local Currency Gov't Bondsbasis points

Source: Bloomberg, IIF;

2006/2007average

2013/2015average

Lower liquidity

countries in our sample (Chart 46). Sovereign bond turnover in emerging markets remains

generally lower than in mature markets. Market turnover for corporate bonds has also

fallen in most emerging markets, particularly in China, Brazil and Mexico (Chart 47).

Elevated bid-ask spreads also reveal evidence of reduced liquidity in many EM local

currency government bond markets. Spreads have shown a particular tendency to blow

out during stress episodes like the Euro Area debt crisis of 2011 and the Fed taper

tantrum of 2013. Indonesia, Hungary, Brazil and China have witnessed particularly marked

declines (Chart 48). However, it is important to note that assessing long-term trends in bid

-ask spreads requires careful interpretation. Although they can be useful indicators of

illiquidity, particularly in making cross-sectoral comparisons (Chart 49), bid-ask spreads

typically reflect a downward bias, as they are based on publicly available data for quoted

trades on exchange markets, which are more liquid compared to over-the-counter

trades.2,3

0

20

40

60

80

100

120

140

2000 2002 2004 2006 2008 2010 2012 2014

EmergingEmergingEmergingEmerging Markets: Bond Turnover Markets: Bond Turnover Markets: Bond Turnover Markets: Bond Turnover ratio, quarterly trading volumes over outstanding bonds

Local Currency Bonds

Hard Currency Corporate Bonds

Hard Currency Government Bonds

Source: EMTA, BIS, IIF.


MXBR

JP

HK

KR

MY

PH

SG

TH

US

ID

CN

2

3

4

5

6

7

8

9

2 3 4 5 6 7 8 9

SovereignSovereignSovereignSovereign Bonds: Turnover Ratios in 2007 vs 2014Bonds: Turnover Ratios in 2007 vs 2014Bonds: Turnover Ratios in 2007 vs 2014Bonds: Turnover Ratios in 2007 vs 2014log of turnover ratio

Source: SIFMA, ABO, BIS, IIF.

2007

2014

Lower liquidity



2. Frank J. Fabozzi, “Institutional Investment Management: Equity and Bond Portfolio Strategies and Applications”, August 2009.

3. Bao, J., J. Pan, and J. Wang, “Liquidity of Corporate Bonds,” MIT, March 2008



Regulatory factors and changes in market structure have contributed to lower liquidityRegulatory factors and changes in market structure have contributed to lower liquidityRegulatory factors and changes in market structure have contributed to lower liquidityRegulatory factors and changes in market structure have contributed to lower liquidity

The evident impairment of secondary bond market liquidity particularly during global

stress episodes highlights the importance of international players—both broker-dealers

and banks—in EM debt markets. Regulatory changes—particularly capital charges and

limits on proprietary trading activity—have driven up the cost of holding inventory for

broker-dealers (e.g. large banks and securities firms) and reduced dealer risk tolerance.

As a result, primary dealers’ appetite for facilitating secondary market bond transactions

has been substantially reduced in many mature markets (Chart 50). Given that a

significant proportion of transactions in EM hard currency debt is handled by

international broker-dealers domiciled in mature markets, intermediation of EM debt

securities has been affected by the same change in incentives—for example, while the

share of foreign bookrunners in EM bond markets has recovered in recent years, it

remains below pre-crisis levels (Chart 51). Of note, U.S. dealers have reduced their

corporate and foreign bond holdings by more than 65% since 2007, reflecting reduced

market-making in EM markets.

Primary dealers in EM local currency sovereign and corporate debt markets also include

subsidiaries of major foreign banks headquartered in mature markets, though to a

varying extent across countries depending on foreign banks’ presence in emerging

markets and regulatory restrictions across jurisdictions (Chart 52). As part of overall de-

risking and deleveraging efforts, many of these international bank subsidiaries have

allocated less capital to market-making activities in EM debt markets. Higher capital

charges on bank holdings of EM bonds, as part of international regulators’ efforts to

reduce systemic risk since the crisis, have also contributed to the pullback.

The rapid development of EM local currency corporate bond markets has far out-

stripped the growth of secondary markets and these markets remain largely illiquid.

Participation of foreign investors remains particularly limited, with only around $45 billion

out of $5.6 trillion of local currency financial corporate bonds effectively tradable by

0

2

4

6

8

10

12

14

16

2003 2005 2007 2009 2011 2013 2015

U.S. PrimaryU.S. PrimaryU.S. PrimaryU.S. Primary Dealer Bond Trading TurnoverDealer Bond Trading TurnoverDealer Bond Trading TurnoverDealer Bond Trading Turnovertrading volumes over total stock of Treasuries/corporate bonds

Corporate BondsGovernment Securities

Source: FED, IIF.


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2010 2011 2012 2013 2014 2015

EM USDEM USDEM USDEM USD Denominated Denominated Denominated Denominated Corporate Bonds: BidCorporate Bonds: BidCorporate Bonds: BidCorporate Bonds: Bid----AskAskAskAsk SpreadSpreadSpreadSpreadbid-ask spread (ask minus the bid divided by mid-price)

Investment Grade

High Yield


15

25

35

45

55

2000 2005 2010 2015

Share of Share of Share of Share of Foreign Foreign Foreign Foreign Bookrunners in EM Bond Bookrunners in EM Bond Bookrunners in EM Bond Bookrunners in EM Bond Markets Markets Markets Markets % of all bookrunners

Source: Thomson One, IIF.




global investors—in part reflecting the lack of global benchmark indices for EM local

currency corporate bonds.4

All that said, the decline of EM secondary market liquidity should not be solely

attributed to regulatory changes. Indeed, lower liquidity (e.g. a reduction in trading

volumes) has also been a feature of EM equity markets, due in part to the decline in

investor interest in this asset class in the weak-growth environment of recent years (Chart

53). Other structural changes on the investor side have also contributed to the reduction

in secondary market liquidity. For example, institutional investors with long-term

investment horizons in emerging markets, such as pension funds and insurance

companies, are becoming increasingly important holders of EM bonds. Notably, such

investors tend to adopt a buy-and-hold-strategy, and the current low-rate environment

has prompted many to allocate more resources to fixed income securities. Taken

together, these changes have fed into a bigger concentration in ownership of EM bonds

over the past few years, which in turn has led to a further reduction in turnover. In

addition, the majority of EM domestic banks still hold a significant proportion of their

sovereign (and particularly corporate) bond holdings until maturity, putting further

downward pressure on turnover ratios. While a greater concentration of buy-and-hold

investors also means less demand for liquidity (as such investors tend not to sell during

stress episodes), less turnover nonetheless represents a structural reduction in secondary

market liquidity.

To what extent do mutual funds and ETFs enhance liquidity in emerging markets?To what extent do mutual funds and ETFs enhance liquidity in emerging markets?To what extent do mutual funds and ETFs enhance liquidity in emerging markets?To what extent do mutual funds and ETFs enhance liquidity in emerging markets?

With increasingly limited liquidity and significant transaction costs in emerging market

securities, retail and to a lesser degree institutional investors have increasingly turned to

non-dealer, non-bank entities as intermediaries in EM bond markets over the past

several years. The rise in the use of mutual funds and ETFs in cross-border EM portfolio

0

1

2

3

4

5

0.4

0.5

0.6

0.7

0.8

0.9

1.0

2005 2007 2009 2011 2013 2015

EMs (excl. China)

China (rhs)

EquityEquityEquityEquity Market TurnoverMarket TurnoverMarket TurnoverMarket Turnovermultiples of market cap, annualized (both scales)

Source: World Federation of Exchanges, IIF.

0

10

20

30

40

50

60

70

80

90Share of Foreign Banks in Total BankingSystem, by Asset Size# of Foreign Banks (%)

ForeignForeignForeignForeign Bank Presence in Emerging MarketsBank Presence in Emerging MarketsBank Presence in Emerging MarketsBank Presence in Emerging Marketspercent

Source: Bankscope, IIF.


4 Of the $13.5 trillion EM debt universe, only around $2.9 trillion is directly accessible to global investors as

bulk of the outstanding bonds are either hold by domestic institutional investors or cannot be traded

outside the local markets amid regulatory restrictions, particularly in China and India.

The decline of EM The decline of EM The decline of EM The decline of EM secondary market secondary market secondary market secondary market liquidity should liquidity should liquidity should liquidity should not be solely not be solely not be solely not be solely attributed to attributed to attributed to attributed to regulatory regulatory regulatory regulatory changes. changes. changes. changes.



investment has been particularly striking, with funds investors’ allocations to EM fixed

income securities almost doubling between 2008 and 2013. Fund investors’ EM bond

and equity allocations comprise around 25% and 50% of the total outstanding cross-

border bond and equity investment in emerging markets, respectively (Charts 54 and

55). Notably, the marked increase in the EM allocations of open-ended funds (Chart 56),

which provide at least the appearance of liquidity by allowing investors to add or

redeem investment at any time, has been the main factor behind this rapid growth. As

such funds, particularly ETFs, appear to offer more liquidity than the cash market for

their underlying securities, they have been very attractive for both retail and institutional

investors planning to expand their exposure to less-liquid markets, such as emerging

market bonds and high-yield corporate bonds.5

Although open-ended funds have often been successful in providing market liquidity

since the 2008 crisis, secondary market turnover has as a consequence become

increasingly dependent on the portfolio allocation decisions of fund investors,

particularly during stress episodes. As investors in open-ended funds have the right to

redeem their shares on demand, and with “herding” behavior among such funds on the

rise,6 large redemptions during stress episodes could require open-ended funds—

particularly those with limited cash buffers—to sell underlying assets very quickly. Given

the limited liquidity of the underlying assets, large-scale sales during stress episodes

could have a significant impact on market liquidity and asset prices—in a manner

reminiscent of the 2013 taper tantrum (Charts 43, 56 and 57).


-5

0

5

10

15

20

2011 2013 2015

ETFs: EM USD Bonds ETFs: EM USD Bonds ETFs: EM USD Bonds ETFs: EM USD Bonds bid-ask spread (ask minus bid price over mid-price)

Source: Bloomberg, IIF; ishares J.P. Morgan,USD EM Bond fund


5 Institutional investors comprise around 99% of EM bond allocations of ETFs, while they account for

around 45% of EM bond allocations of open-end mutual funds.

6 As noted by the IMF and the BIS, fund managers tend to shift their asset allocations in a correlated

manner as their investment strategies are largely concentrated on benchmarks. Indeed, herding has been

on the rise since the 2008 crisis, with more pronounced herd behavior in less liquid markets such as EM

bond and equity markets. Notably, retail investors exhibit a slightly higher herding tendency compared to

institutional investors, though the persistent rise in herding has been a common practice regardless of the

investor type since the crisis.

0.0

0.4

0.8

1.2

1.6

0

5

10

15

20

25

2007 2010 2013

CrossCrossCrossCross----Border Investment in Border Investment in Border Investment in Border Investment in EM Bonds via FundsEM Bonds via FundsEM Bonds via FundsEM Bonds via Funds% of total nonresidential invest. in EM bonds, 2007-2013

ETFs

Mutual Funds

Source: CPIS, EPFR, IIF.

3

5

7

9

11

252729313335373941

2007 2010 2013

ETFs

Mutual funds

Source: CPIS, EPFR, IIF.

CrossCrossCrossCross----Border Investment in Border Investment in Border Investment in Border Investment in EM Equities via FundsEM Equities via FundsEM Equities via FundsEM Equities via Funds% of total nonresidential invest. in EM equities, 2007-2013



0

2

4

6

8

10

12

14

2008 2009 2010 2011 2012 2013 2014 2015

EmergingEmergingEmergingEmerging Market Bonds: Fund Portfolio WeightsMarket Bonds: Fund Portfolio WeightsMarket Bonds: Fund Portfolio WeightsMarket Bonds: Fund Portfolio Weightspercent, valuation adjusted series

Open-end Mutual Funds

Source: IIF, EPFR.

ETFs

Close-end Mutual Funds

https://www.imf.org/External/Pubs/FT/GFSR/2015/01/pdf/c3.pdf

http://www.bis.org/publ/qtrpdf/r_qt1409e.pdf



EMERGING ASIA: LIVING WITH VOLATILITYEMERGING ASIA: LIVING WITH VOLATILITYEMERGING ASIA: LIVING WITH VOLATILITYEMERGING ASIA: LIVING WITH VOLATILITY

We project aggregate non-resident private capital flows to Emerging Asia in 2015 to fall

well below 2014 levels and the 2013 high before some recovery in 2016 (Chart 58). A

large share of the projected reduction in 2015 reflects weaker capital flows to China due

to changing exchange rate dynamics and the impact on corporate behavior. Flows to EM

Asia outside China are likely to be restrained in advance of the Fed liftoff. However,

despite the uncertainty, the region should continue to benefit from still outperforming

growth along with commitment to macroeconomic stability and gradual reforms. In

particular, policy stimulus to prop up growth and continuing reforms in China, improving

fundamentals in India, and more focus on macrostabilization and structural challenges in

Indonesia, the three leading regional destinations, should provide support to inflows.

In China, the year got off to a very weak start as Chinese corporations sought to reduce

dollar exposure in the face of dollar strength, monetary policy easing, and more two-way

movement in the RMB. This led to both a decline in non-resident inflows and rising

resident outflows, implying a significant loss in international reserves in Q1 (Chart 59). We

expect an improving trend for the remainder of 2015 and into 2016. Non-resident inflows

should be supported by signs of an economic turnaround as stimulus measures take

effect, by interest in the booming stock market, and by further steps to reduce barriers to

fixed–income and equity inflows.

In late March, central bank governor Zhou set the stage by calling for a "basically open

capital account" by the end of 2015, partly with an eye to the inclusion of the RMB in the

SDR basket in the IMF review later this year. We expect further substantive liberalization

of the regimes controlling both inflows and outflows, although not a full dismantling of

quotas or “big bang” liberalization, with reforms focusing more on opening up to non-

resident inflows in order to avoid weakening the balance of payments position. Overall,

we expect a return to small reserve accumulation, supported by the trade surplus as well

as net capital inflows later in 2015 and into 2016.

Outside China, portfolio capital flows to the region were quite sizeable early this year -

supported by indications that Fed tightening would be delayed and follow a gradual

Bejoy Das Gupta

Chief Economist Asia/Pacific 1-202-857-3649 [email protected]

0

1

2

3

4

5

6

7

-200

-100

0

100

200

300

400

500

600

700

800

2008 2009 2010 2011 2012 2013 2014 2015 2016

Nonbank Bank Lending

Inward Portfolio Equity Inward Direct Equity

Net Private Capital Inflows to Emerging AsiaNet Private Capital Inflows to Emerging AsiaNet Private Capital Inflows to Emerging AsiaNet Private Capital Inflows to Emerging Asia$ billion percent of GDP

Source: IIF.

% of GDPIIF Forecast


-300-250-200-150-100-50050100150200

2013 2014 2015

Other Inflows Other OutflowsPortfolio Debt Inflows Portfolio Debt OutflowsPortfolio Equity Inflows Portfolio Equity OutflowsFDI ODIReserves (- = increase) Current Account Balance

China: Capital Flows and Current AccountChina: Capital Flows and Current AccountChina: Capital Flows and Current AccountChina: Capital Flows and Current Account BalanceBalanceBalanceBalance$ billion

Source: SAFE, IIF.

IIF Forecast


Aggregate private Aggregate private Aggregate private Aggregate private capital inflows to capital inflows to capital inflows to capital inflows to Emerging Asia will Emerging Asia will Emerging Asia will Emerging Asia will fall in 2015 to fall in 2015 to fall in 2015 to fall in 2015 to below the 2013 below the 2013 below the 2013 below the 2013 high before some high before some high before some high before some recovery in 2016recovery in 2016recovery in 2016recovery in 2016



path - but dropped in May (Chart 60). External bond issuance remained large as issuers

took advantage of low yields and ample demand in advance of Fed policy tightening

(Chart 61). The outlook is for flows to remain at moderate levels, with continuing

volatility related to shifting expectations about Fed liftoff.

Countries with large foreign holdings of domestic bonds such as Malaysia and Indonesia

are likely to be particularly affected by shifts in market views about the Fed (Chart 62).

Malaysia has become more vulnerable because, as an oil and gas exporter, it has lost

the cushion of its previously large current account surplus. In Indonesia, the sizeable

external financing requirement means that the central bank has to keep monetary policy

tight, despite a soft economy. The new Jokowi government still has work to do to

navigate political challenges to improve the business climate and tackle infrastructure

bottlenecks. A sharper-than-expected slowdown in China could also negatively impact

growth and flows in the region, including export-dependent Korea. Growth in a number

of countries in the region, including Thailand, Korea and Indonesia, is also dependent

on the advancing of planned fiscal stimulus, in the absence of which FDI and portfolio

equity inflows could be impacted.

In India, after a tantrum-related dip in 2013, private capital inflows rose sharply in the

run up to and following the election of Prime Minister Modi last May, bolstered by rising

expectations of reforms to strengthen the economy’s foundations. In practice, reforms

have been incremental but still helpful to encourage inflows. In particular, FDI is being

spurred by the raising of ownership limits for insurance, defense, pensions and opening

up of railways projects along with the stepped-up focus on cutting red tape and tax

reform. While there was a pullback in portfolio equity inflows recently following the

minimum alternative tax (MAT) being applied to pre-April 2015 capital gains of foreign

portfolio investors from non-treaty countries, this should prove temporary as the

government intends to resolve the issue soon. Limits on foreign holdings of domestic

bonds and maturing of Non-resident Indian (NRI) deposits could dampen net inflows,

although India should be better placed to weather a broader EM stress episode when

the Fed starts to raise rates than at the time of the 2013 tantrum because of improved

macro management, reduced external financing needs and better reform prospects.

-30

-20

-10

0

10

20

2013 2014 2015

Equity Debt Total

Portfolio Flows to EMPortfolio Flows to EMPortfolio Flows to EMPortfolio Flows to EM AsiaAsiaAsiaAsia$ billion

Source: National Sources, IIF. Includes India, Indonesia, Malaysia, Philippines, South Korea, and Thailand. *Through May 22, 2015. **Debt flows in May only include India, Indonesia, and Thailand.


0 10 20 30 40 50

China*

India

Thailand

Korea

Indonesia

Malaysia

Local CurrencyGovernment BondsEquity

Foreign Holdings ofForeign Holdings ofForeign Holdings ofForeign Holdings of Domestic Domestic Domestic Domestic SecuritiesSecuritiesSecuritiesSecuritiespercent of total

Source: National Sources, CEIC, IIF. *Includes gov't and corporate bonds.


0

5

10

15

20

25

30

2013 2014 2015

EMEMEMEM Asia: External Bond Asia: External Bond Asia: External Bond Asia: External Bond IssuanceIssuanceIssuanceIssuance$ billion

Source: ThomsonOne. *15Q2 through May 14.


Countries with Countries with Countries with Countries with large foreign large foreign large foreign large foreign holdings of holdings of holdings of holdings of domestic bonds domestic bonds domestic bonds domestic bonds will be most will be most will be most will be most affected by shifts affected by shifts affected by shifts affected by shifts in market views in market views in market views in market views about the Fedabout the Fedabout the Fedabout the Fed

A sharperA sharperA sharperA sharper----thanthanthanthan----expected expected expected expected slowdown in China slowdown in China slowdown in China slowdown in China could negatively could negatively could negatively could negatively impact growth and impact growth and impact growth and impact growth and flows in the regionflows in the regionflows in the regionflows in the region



EMERGING EUROPE: POLITICS STILL THE KEYEMERGING EUROPE: POLITICS STILL THE KEYEMERGING EUROPE: POLITICS STILL THE KEYEMERGING EUROPE: POLITICS STILL THE KEY

Nonresident capital inflows to Emerging Europe have reversed sharply since the middle

of 2014, mainly driven by sizable outflows from Russia. These outflows cut the full year

inflows of foreign capital to Emerging Europe to $40 billion in 2014 from $213 billion in

2013. Outflows continued in the first quarter of 2015. However, foreign capital inflows

are expected to return in the second half of 2015 assuming that the Russia/Ukraine con-

flict stabilizes and the Fed lift off is gradual. This should give rise to a moderate increase

in foreign capital inflows on an annual basis in 2015 relative to 2014 before moving up

more strongly in 2016.

Foreign capital outflows from Russia accelerated to $31 billion during January-March

2015, from $24 billion a quarter during the second half of 2014 (Chart 63). The accelera-

tion was centered in portfolio equity and bank-related outflows, although Russian compa-

nies were able to step up their Eurobond issuances during the first quarter as some re-

covery in oil prices helped to stabilize economic conditions. This boosted international

bond issuance in the region to $19 billion during January-March from $7 billion a quarter

during June-December 2014 (Chart 64). Foreign holdings of local currency government

bonds, meanwhile, fell in Turkey, Hungary and Russia during the first quarter of 2015

(Chart 65). Given the importance of portfolio capital inflows to finance Turkey’s still siza-

ble current account deficit, intensified concerns about the Turkish central bank’s ability to

resist pressures from the government to ease monetary policy led foreign investors to

reduce their exposure to Turkey in early 2015.

Outside Russia, bank related credits have benefited from the ECB’s QE since January.

This helped banks in Emerging Europe access foreign funding more easily, especially

those in countries where credit demand remained strong, such as Turkey. Banks in Tur-

key increased their net foreign borrowing to $10 billion during the first quarter of 2015

from $8 billion a quarter during the second half of 2014. With credit demand remaining

weak and current accounts in surplus, banks in most of CEE as well as Russia continued

to make net foreign bank credit repayments during January-March 2015.

-150

-100

-50

0

50

100 Resident

Foreign

2011 2012 2013 2014Source: Bank of Russia.

Russia: CapitalRussia: CapitalRussia: CapitalRussia: Capital FlowsFlowsFlowsFlows$ billion

Source: Bank of Russia, IIF.

Net Capital


0

5

10

15

20

25

14Q1 14Q2 14Q3 14Q4 15Q1

CEE

Russia

Turkey

EmergingEmergingEmergingEmerging Europe: Eurobond Issuance, GrossEurope: Eurobond Issuance, GrossEurope: Eurobond Issuance, GrossEurope: Eurobond Issuance, Gross$ billion

Source: IIF.


Ugras Ulku Senior Economist Emerging Europe 1-202-857-3617 [email protected]

Nonresident Nonresident Nonresident Nonresident capital inflows to capital inflows to capital inflows to capital inflows to Emerging Europe Emerging Europe Emerging Europe Emerging Europe have reversed have reversed have reversed have reversed sharply since the sharply since the sharply since the sharply since the middle of 2014middle of 2014middle of 2014middle of 2014

Bank related Bank related Bank related Bank related credits have credits have credits have credits have benefited from the benefited from the benefited from the benefited from the ECB’s QE since ECB’s QE since ECB’s QE since ECB’s QE since JanuaryJanuaryJanuaryJanuary



After taking out roughly $130 billion in 2014, residents in Russia repatriated a moderate

$2.8 billion during January-March 2015 as confidence in local stability improved. As a

result, resident outflows from Emerging Europe slowed to $20 billion in the first quarter

from $66 billion in the last quarter of 2014 ($60 billion of which was from Russia). Capital

outflows from Russia, both foreign and resident, brought the ruble under extreme de-

preciation pressures in 2014, prompting the Russian central bank to intervene heavily.

This was the main reason that Emerging Europe’s FX reserves fell by a cumulative

$108 billion last year. Foreign exchange reserves declined further in the first quarter of

2015 by a cumulative $9 billion, again mainly driven by Russia.

Net inflows of nonresident capital to the region are projected to increase from

$40 billion last year to $86 billion this year as a whole and further to $131 billion in 2016

(Chart 66). Assuming no escalation of the Russia-Ukraine conflict, private foreign capital

outflows look likely to continue at a moderate pace from both countries during the re-

mainder of 2015. The rest of the region should benefit from rising inflows, provided that

the Fed rate hikes occur at a gradual pace and that the ECB’s QE ensures continued

easy funding conditions (even in the event of a Greek exit from the euro). After the June

parliamentary elections in Turkey, political uncertainty should dissipate, leading to a

pick-up in foreign capital inflows to Turkey during the second half of 2015 assuming that

key figures in Turkey’s economic team remain in office. Ukraine, meanwhile, will remain

shut off from private markets as it goes through a restructuring of private debt in the

context of its IMF program.

Downside risks to foreign capital inflows remain substantial, especially if the Fed’s tight-

ening leads to a broad selloff of emerging market assets or if the Russian-Ukraine con-

flict escalates. If Greece exits the euro, the resulting uncertainty might prompt some

investors to sell at least part of their assets in neighboring countries. Moreover, a signifi-

cant loss of confidence in Turkey’s economic management after the June elections

could also prompt foreign investors to reduce their exposure to Turkish assets.

-15

-10

-5

0

5

10

15

14Q1 14Q2 14Q3 14Q4 15Q1

Russia Hungary

Poland Turkey

Czech Republic

EmergingEmergingEmergingEmerging Europe: Net Foreign Purchases of Local Currency Europe: Net Foreign Purchases of Local Currency Europe: Net Foreign Purchases of Local Currency Europe: Net Foreign Purchases of Local Currency Denominated Government BondsDenominated Government BondsDenominated Government BondsDenominated Government Bonds$ billion

Source: IIF.


-50

0

50

100

150

200

250

300

2011 2012 2013 2014 2015 2016

Nonbanks Debt FDI

Bank Lending Portfolio Equity

EmergingEmergingEmergingEmerging Europe: Foreign Private Capital InflowsEurope: Foreign Private Capital InflowsEurope: Foreign Private Capital InflowsEurope: Foreign Private Capital Inflows$ billion

Source: IIF.

Total

IIF Forecast


Downside risks to Downside risks to Downside risks to Downside risks to foreign capital foreign capital foreign capital foreign capital inflows remain inflows remain inflows remain inflows remain substantialsubstantialsubstantialsubstantial

Resident outflows Resident outflows Resident outflows Resident outflows from Emerging from Emerging from Emerging from Emerging Europe slowed in Europe slowed in Europe slowed in Europe slowed in the first quarter the first quarter the first quarter the first quarter



LATIN AMERICA: STILL IN THE GAMELATIN AMERICA: STILL IN THE GAMELATIN AMERICA: STILL IN THE GAMELATIN AMERICA: STILL IN THE GAME

Private capital inflows to the region have revived somewhat in the first months of the

year, helped by receding market fears of further depreciation of local currencies and indi-

cations that Fed liftoff would be at a gradual pace. Nonetheless, we still forecast private

capital inflows to Latin America to decline this year vis-à-vis 2014 due to the impending

monetary tightening by the Fed and sluggish economic growth. Private capital inflows

should gain strength next year as macroeconomic fundamentals and growth prospects in

the region’s largest economies improve (Chart 67). In Brazil, the ongoing policy adjust-

ment should create the conditions for some growth recovery; in Mexico, the economy

should benefit from solid U.S. growth and reform implementation; and in Argentina, a

new, more pragmatic administration, post presidential elections in October, is widely

expected to resolve the holdout creditors issue, thereby re-opening the country to global

financial markets.

Foreign purchases of local currency securities resumed in early 2015 (Chart 68). This

largely reflects a turnaround in flows to Brazil as the central bank has progressively tight-

ened monetary policy and fiscal policy has been put on a consolidation path. Inflows for

the purchase of local currency securities have also been resilient in Colombia and Peru,

although Mexico has seen outflows in recent months, mainly in short term instruments,

reflecting heightened FX volatility and a portfolio rebalancing towards higher yielding

assets.

Portfolio equity inflows to the region rebounded in the first part of this year following

outflows at the end of 2014 (Charts 69 and 70). Inflows are being spurred by idiosyncratic

factors, strategic market positioning, and greater exchange rate stability. In Brazil, a ma-

jor factor boosting the stock market was the release of Petrobras’ 2014 audited financial

statements, whose delay had contributed to increasing uncertainty about growth pro-

spects (Chart 71). Mexico has also attracted portfolio equity as investors positioned

themselves for stronger growth in the second half of the year and in 2016 amid increased


-10-8-6-4-20246810121416

Mar 14 Jun 14 Sep 14 Dec 14 Mar 15

PeruColombiaMexicoBrazil

Latin America: Inflows intoLatin America: Inflows intoLatin America: Inflows intoLatin America: Inflows into Local Sovereign Debt MarketsLocal Sovereign Debt MarketsLocal Sovereign Debt MarketsLocal Sovereign Debt Markets$ billion

Source: IIF based on national sources


Ramón Aracena Chief Economist Latin America 1-202-857-3630 [email protected]

Private capital Private capital Private capital Private capital inflows to the inflows to the inflows to the inflows to the region have region have region have region have revived somewhat revived somewhat revived somewhat revived somewhat in the first months in the first months in the first months in the first months of the yearof the yearof the yearof the year

-1

0

1

2

3

4

5

6

7

8

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Non Bank DebtBank LendingPortfolio EquityFDI

Latin America:Latin America:Latin America:Latin America: Foreign Private Capital Inflows Foreign Private Capital Inflows Foreign Private Capital Inflows Foreign Private Capital Inflows percent of GDP

Source: IIF.

IIF Forecast



reform-related opportunities in key sectors of the economy. By contrast in Chile, debt

inflows have dominated as banks and corporates pre-finance themselves in anticipation

of higher external borrowing costs.

Even Argentina has raised private FX financing despite its noncompliance with the NY

district court ruling on holdout creditors. In April, the government issued, under domestic

law, a dollar bond for $1.4 billion in the local market (Bonar 2024), which reportedly, has

been sold overseas. Further FX debt issues, even under local law, however, run the risk of

legal action as the Republic is already in contempt of court. Also in April, the state oil

company, YPF, raised $1.5 billion abroad. We expect private capital inflows to Argentina

to revive next year assuming that whoever wins the presidency this year will quickly reach

an agreement with holdout creditors in order to normalize access to global capital mar-

kets and restart growth.

Reluctant to implement the policy shift needed to adjust the economy to lower oil reve-

nues, Venezuela has resorted to multiple channels to maximize external borrowing. Dur-

ing the first four months of the year, the Republic secured a $5 billion loan from China;

issued $2.8 billion in bonds through Citgo (PDVSA’s refining unit in the U.S.), settled Pet-

roCaribe debt with the Dominican Republic ($1.9 billion), and entered into a $1.0 billion

cash-for-gold swap with Citibank. However, deepening policy imbalances and sizable

external debt service coming due have intensified pressure on international reserves and

failed to dispel the specter of default. With financing options rapidly narrowing and no

signs of a coherent policy adjustment in sight, we expect reserves to continue to decline

this year and next, thereby, raising the risk of a default on external obligations.

Despite improved prospects for 2016, the region remains vulnerable to heightened finan-

cial volatility. If this were to happen, we expect across-the-board currency depreciation

and slower growth recovery momentum, taking a toll on our envisaged outlook for capi-

tal flows.

-15

-10

-5

0

5

10

15

20

Dec 14 Jan 15 Feb 15 Mar 15 Apr 15

Brazil

Colombia

Chile

Mexico

LatinLatinLatinLatin America: America: America: America: Stock Market ReturnsStock Market ReturnsStock Market ReturnsStock Market Returns in $ terms in $ terms in $ terms in $ terms percent m/m, $ terms

Source: Bloomberg.


-3

-1

1

3

5

7

9

Mar 14 Jun 14 Sep 14 Dec 14 Mar 15

Chile

Brazil

Mexico

Latin America: PortfolioLatin America: PortfolioLatin America: PortfolioLatin America: Portfolio Equity Inflows Equity Inflows Equity Inflows Equity Inflows $ billion

Source: IIF based on National Sources.


1.5

2.0

2.5

3.0

3.5

2013 2014 2015

Chart XChart XChart XChart XBrazil: Exchange RateBrazil: Exchange RateBrazil: Exchange RateBrazil: Exchange Ratereais per $

We expect private We expect private We expect private We expect private capital inflows to capital inflows to capital inflows to capital inflows to Argentina to Argentina to Argentina to Argentina to reviverevivereviverevive next year next year next year next year




MENA: DIGESTING LOWER OIL PRICESMENA: DIGESTING LOWER OIL PRICESMENA: DIGESTING LOWER OIL PRICESMENA: DIGESTING LOWER OIL PRICES

Capital inflows to our selected five MENA countries (the UAE, Saudi Arabia, Egypt,

Morocco, and Lebanon) are projected to increase slightly to $70.8 billion in 2015 driven

by an increase in FDI and official loans in Egypt and a significant increase in portfolio

investment in Saudi Arabia. The largest component of private inflows remains FDI, which

accounts for more than half of the total (Chart 72).

Private capital flows to the UAE remains the highest among MENA counties. The Emir-

ates has been the beneficiary of private capital flows from other MENA countries follow-

ing the political unrest in the Arab world since 2011. FDI more than doubled to $14.5

billion and portfolio flows have increased five-fold from 2011 to 2014. Capital flows to

domestic banks have also risen sharply. However, the strong U.S. dollar has made the

real estate market more expensive for foreign investors and may adversely affect FDI.

In Saudi Arabia, a relatively closed market is being opened up in June, as foreigners will

be allowed to buy shares listed on the Tadawul stockmarket (see Saudi Arabia: Opening

Capital Markets to Foreign Investment, May 2015). This could boost foreign portfolio

inflows in the second half of this year and in 2016 (Chart 73).

In Egypt, private inflows revived in 2014 on the back of greater political stability, and are

expected to rise further in 2015. Efforts are under way to tackle the regulatory and bu-

reaucratic obstacles that stand in the way of investors. Encouraged by the political stabil-

ity and improvements in the business environment, investors and governments from

around the globe have recently pledged to invest around $30 billion in Egypt over the

next four years. Inflows will be supported by the recent $6 billion deposit at the Central

Bank of Egypt from Saudi Arabia, the UAE and Kuwait which will help to boost official

reserves (Chart 74).

In Morocco, the capital and financial accounts are expected to improve further,

particularly FDI, as political and social stability and improvement in the business environ-

ment make Morocco an attractive destination.

Garbis Iradian Chief Economist Middle East and North Africa 1-202-857-3304 [email protected]

03691215182124273033

2014

2015

2016

2014

2015

2016

2014

2015

2016

2014

2015

2016

2014

2015

2016

Private Creditors

Portfolio Investment

Direct Investment

Private Inflows to Selected MENA EconomiesPrivate Inflows to Selected MENA EconomiesPrivate Inflows to Selected MENA EconomiesPrivate Inflows to Selected MENA Economies$ billion

U.A.E. Saudi A. Egypt Morocco Lebanon

Source: IIF.


-2

0

2

4

6

8

10

12

14

2010 2011 2012 2013 2014 2015 2016

Private Flows

Official flows, net

Egypt: Net Private and Official FlowsEgypt: Net Private and Official FlowsEgypt: Net Private and Official FlowsEgypt: Net Private and Official Flows$ billion

Source: Central Bank of Egypt and IIF Forecast for 2015 and 2016.


0

20

40

60

80

2014 2015 2016

Other

Portfolio

FDI

MENA: Private InflowsMENA: Private InflowsMENA: Private InflowsMENA: Private Inflows$ billion

Source: IIF.


https://www.iif.com/publication/research-note/saudi-arabia-opening-capital-markets-foreign-investment



Until recently, MENA oil exporting countries (Saudi Arabia, UAE, Qatar, Kuwait, Oman,

Bahrain, Algeria, Iran, Iraq and Libya) were major exporters of capital (Chart 75), recycling

their huge oil and gas revenues. Their combined current account surplus peaked at $432

billion in 2012, but this surplus has disappeared as the oil price has dropped while do-

mestic spending has been largely sustained supported. As a result, the aggregate current

account is projected to shift to a deficit of $45 billion in 2015 from a surplus of $248

billion in 2014. Accordingly, we project a dramatic swing from resident capital outflows of

around $380 billion in 2012 to a small net inflow of $50 billion in 2015. Resident capital

outflow would increase modestly in 2016 as oil prices recover to around $70/bbl. Net

foreign assets of MENA exporting countries are expected to decline by about $100 bil-

lion to $2.45 trillion in 2015 (Chart 76), about half of the assets are managed by SWFs

with diversified portfolios of public equities, fixed income securities, and minority shares

in global companies, while the other 45% is in official reserves, mostly of Saudi Arabia,

and is invested in liquid assets, notably highly rated government debt securities and

deposits with banks abroad. The projected decline in foreign assets for will be reflected

in the running down of reserves (by $79 billion in Saudi Arabia, $23 billion in Algeria, $13

billion in Iraq, and $24 billion in Libya) and smaller increase SWFs for the UAE, Qatar and

Kuwait (Table 2). The decline in official reserves will lead to lower deposits with foreign

banks and debt securities, while the smaller accumulations in SWFs will be reflected in

smaller FDI and portfolio investment abroad.

600

900

1200

1500

1800

2100

2400

2700

2005 2010 2015Source: IIF

MENA Oil Exportes:MENA Oil Exportes:MENA Oil Exportes:MENA Oil Exportes:Net Foreign AssetsNet Foreign AssetsNet Foreign AssetsNet Foreign Assets$ billion


-400

-300

-200

-100

0

100

200

300

400

500

2008 2010 2012 2014 2016

Resident Capital OutflowsCurrent Account

MENA Oil Exporters:MENA Oil Exporters:MENA Oil Exporters:MENA Oil Exporters: Capital Outflows and Current AccountCapital Outflows and Current AccountCapital Outflows and Current AccountCapital Outflows and Current Account$ billion

Source: IIF.

IIF forecast


-250

-200

-150

-100

-50

0

50

2008 2010 2012 2014 2016

Other

Portfolio Abroad

FDI Abroad

SaudiSaudiSaudiSaudi Arabia plus UAE:Arabia plus UAE:Arabia plus UAE:Arabia plus UAE: Breakdown of Capital OutflowsBreakdown of Capital OutflowsBreakdown of Capital OutflowsBreakdown of Capital Outflows$ billion

Source: IIF.

IIF forecast

Table 2 Table 2 Table 2 Table 2

Current Account Balance, $ bn Official Reserves, $ bn Sovereign Wealth Funds, $ bn

2014 2015 2016 2014 2015 2016 2014 2015 2016

Kuwait 56.5 20.6 29.8 35 37 40 Kuwait Investestment Auth. 404 408 416

Qatar 50.0 6.5 6.8 43 35 35 Qatar Investment Auth. 314 323 327

Saudi Arabia 75.4 -34.8 11.8 732 653 617 UAE SWFs 539 560 587

UAE 48.6 13.0 26.2 78 79 82 Libya Investment Auth. 36 30 25

Algeria -9.6 -25.1 -19.8 179 156 141 Saudi Arabia (AGI) 144 120 110

Iraq 17.2 -11.1 0.1 64 51 45

Libya -17.0 -23.4 -17.3 98 74 56

Source: IIF

MENA Oil Exporters: Current Account Balance, Official Reserves, and Sovereign Wealth FundsMENA Oil Exporters: Current Account Balance, Official Reserves, and Sovereign Wealth FundsMENA Oil Exporters: Current Account Balance, Official Reserves, and Sovereign Wealth FundsMENA Oil Exporters: Current Account Balance, Official Reserves, and Sovereign Wealth Funds



SUB SAHARAN AFRICA: WANING APPETITESUB SAHARAN AFRICA: WANING APPETITESUB SAHARAN AFRICA: WANING APPETITESUB SAHARAN AFRICA: WANING APPETITE

We expect capital flows to Sub Saharan Africa to pick up slightly following the recent

period of heightened volatility driven by the slump in oil prices, elections in Nigeria and

continued global uncertainty over the timing of U.S. monetary policy tightening. Overall

flows are likely to remain subdued, however, dampened by weak commodity prices.

In Nigeria, portfolio outflows in Q4 2014 likely continued in the first few months of 2015

as evidenced by a further decline in official reserves (Chart 78). This may turn out to be

the low point, however, as a decisive election victory for the opposition and an orderly

transfer of power have reduced uncertainty and fuelled a strong post-election rebound in

financial markets. Nonetheless, the new Buhari government faces enormous economic

challenges as both fiscal and monetary policy will remain restrictive and growth subdued.

Against this background, we expect capital inflows to remain weak this year and next,

notwithstanding a recovery in investment if/when promised reforms are implemented.

Portfolio flows into South Africa, which held up reasonably well in 2014 despite swings in

sentiment influenced by both global market gyrations and local events, have continued

to ebb and flow this year. After outflows in January and February, sentiment reversed in

March, benefiting equities (Chart 79). A tighter fiscal stance, continued weak growth and

a drop in inflation in early 2015 have reduced pressure on monetary policy. However, we

still expect the SARB to raise rates later this year with the timing dependent on the Fed

and how quickly inflation picks up from its recent trough. This suggests that capital in-

flows will remain weak this year, with noticeable improvement only when confidences

picks up and growth improves.

Inflows into other Sub-Saharan Africa countries will again be mainly FDI and through

international bond issues (Chart 80). Given the diversification benefits offered by frontier

markets, we expect continued appetite for sovereign issues. Cote d’Ivoire has already

issued a $1 billion bond this year, Kenya will probably tap the markets again following its

successful debut in 2014, Tanzania has taken steps for a maiden issue in FY2015/16, and

cash-strapped Ghana has indicated that it will go back to the market now that an IMF

program is in place.

20

25

30

35

40

45

50

Apr 13 Jul 13 Oct 13Jan 14Apr 14 Jul 14 Oct 14Jan 15Apr 15

Nigeria: Gross Foreign ReservesNigeria: Gross Foreign ReservesNigeria: Gross Foreign ReservesNigeria: Gross Foreign Reserves$ billion

Source: Nigeria Central Bank.


-2

-1

0

1

2

3

4

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

South Africa: Nonresidents' Purchases/Sales of EquitiesSouth Africa: Nonresidents' Purchases/Sales of EquitiesSouth Africa: Nonresidents' Purchases/Sales of EquitiesSouth Africa: Nonresidents' Purchases/Sales of Equities$ billion, cumulative year-to-date

20132015

2012

Source: South African Reserve Bank

2014


David Hedley Chief Economist Sub-Saharan Africa 1-202-857-3605 [email protected]

We expect capital We expect capital We expect capital We expect capital flows to Sub flows to Sub flows to Sub flows to Sub Saharan Africa to Saharan Africa to Saharan Africa to Saharan Africa to pick up slightly pick up slightly pick up slightly pick up slightly following a period following a period following a period following a period of heightened of heightened of heightened of heightened

0

1

23

4

5

6

7

8

2011 2012 2013 2014

SSA Sovereign Bond SSA Sovereign Bond SSA Sovereign Bond SSA Sovereign Bond Issuance (ExclIssuance (ExclIssuance (ExclIssuance (Excl South Africa)South Africa)South Africa)South Africa)$ billion

Source: Bloomberg.





Emerging Asia: Capital FlowsEmerging Asia: Capital FlowsEmerging Asia: Capital FlowsEmerging Asia: Capital Flows

$ billion 2013 2014 2015 2016








Nonbanks 147 99 71 90


International Financial Institutions 3 3 3 3






Reserves (- = Increase) -455 -181 -181 -273

----285285285285 ----184184184184 ----283283283283 ----227227227227

Memo:

Net Errors and Omissions 62 -85 0 0

Current Account Balance 223 269 284 227






Emerging Europe: Capital FlowsEmerging Europe: Capital FlowsEmerging Europe: Capital FlowsEmerging Europe: Capital Flows

$ billion 2013 2014 2015 2016





Portfolio Investment -2 -7 1 7

Private Creditors 146 -20 18 68


Nonbanks 126 -57 15 28

Official Inflows -4 7 23 4

International Financial Institutions -12 3 20 6

Bilateral Creditors 8 4 3 -2





Reserves (- = Increase) 1 107 22 -19

35353535 ----16161616 ----67676767 ----67676767

Memo:


Current Account Balance -27 21 67 67






Latin America: Capital FlowsLatin America: Capital FlowsLatin America: Capital FlowsLatin America: Capital Flows

$ billion 2013 2014 2015 2016








Nonbanks 135 125 105 113








Reserves (- = Increase) 4 -23 4 -24

167167167167 176176176176 157157157157 146146146146

Memo:


Current Account Balance -142 -165 -157 -146






Africa/Middle East: Capital FlowsAfrica/Middle East: Capital FlowsAfrica/Middle East: Capital FlowsAfrica/Middle East: Capital Flows

$ billion 2013 2014 2015 2016








Nonbanks 22 18 15 17








Reserves (- = Increase) -90 -14 81 31

----134134134134 ----50505050 63636363 ----1111

Memo:


Current Account Balance 166 94 -63 1





IIF CAPITAL FLOWS REPORT COUNTRY SAMPLE (30)IIF CAPITAL FLOWS REPORT COUNTRY SAMPLE (30)IIF CAPITAL FLOWS REPORT COUNTRY SAMPLE (30)IIF CAPITAL FLOWS REPORT COUNTRY SAMPLE (30)

Emerging EuropeEmerging EuropeEmerging EuropeEmerging Europe Bulgaria Latin AmericaLatin AmericaLatin AmericaLatin America Argentina

(8)(8)(8)(8) Czech Republic (8)(8)(8)(8) Brazil

Hungary Chile

Poland Colombia

Romania Ecuador

Russian Federation Mexico

Turkey Peru

Ukraine Venezuela

Emerging AsiaEmerging AsiaEmerging AsiaEmerging Asia China Africa/Middle EastAfrica/Middle EastAfrica/Middle EastAfrica/Middle East Egypt

(7)(7)(7)(7) India ((((7)7)7)7) Lebanon

Indonesia Morocco

Malaysia Nigeria

Philippines Saudi Arabia

South Korea South Africa

Thailand UAE

ANNEX 1: IIF CAPITAL FLOWS DATA ANNEX 1: IIF CAPITAL FLOWS DATA ANNEX 1: IIF CAPITAL FLOWS DATA ANNEX 1: IIF CAPITAL FLOWS DATA –––– A LAYMAN’S GUIDEA LAYMAN’S GUIDEA LAYMAN’S GUIDEA LAYMAN’S GUIDE

Capital flows arise through the transfer of ownership of assets from one country to

another. When analyzing capital flows, we care about who buys an asset and who

sells it. If a foreign investor (a non-resident) buys an emerging market asset, we refer

to this as a capital inflow in our terminology. We report capital inflows on a net

basis. For example, if foreign investors buy $10 billion of assets in a particular

country and sell $2 billion of that country’s assets during the same period, we show

this as a (net) capital inflow of $8 billion. Note that net capital inflows can be

negative, namely if foreign investors sell more assets of a country than they buy in a

given period. Our “net private capital inflows to emerging markets” measure is the

sum of all net purchases of EM assets by private foreign investors.

Correspondingly, if an investor from an emerging market country (a resident) buys a

foreign asset, we call this a capital outflow. Net capital outflows can also be positive

or negative. Following standard balance of payments conventions, we show a net

increase in the assets of EM residents (a capital outflow) with a negative sign.

For further details regarding terminology, concepts and compilation of our data,

please consult our User Guide located on our website at www.iif.com/emr/global/

capflows.

Capital Flows to Emerging Markets MAY 28, 2015

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