The IIF’s Rued Roller Coaster Rut
The IIF’s latest private capital flows tracker to thirty major markets, now to be published quarterly, dropped this and next year’s projections to just over $1 trillion, with emerging economy outbound investment at almost $1.5 trillion, three-quarters outside central bank hard currency recycling, already outstripping the total. Higher global interest rates from near-term Federal Reserve tapering and better industrial world growth will moderate allocation, over half from FDI with about 10 percent from bank lending and the rest portfolio holdings although equity will stay under $100 billion through 2014. Multilateral transfers will be net negative in the short-term and continue to lag bilateral credit mainly for European rescues, while reserve accumulation will be in the $350-$400 billion range. Despite stubborn structural weaknesses across the EM universe explored in a companion study, China as the commodities and trade linchpin seems to have revived 7.5 percent expansion while previously favored destinations like India and Turkey have a less benign outlook with recent turns in the “roller coaster.” However a full-blown asset class crisis is unlikely with better macroeconomic and debt management, and underweight exposure at just above 1 percent of world GDP argues for wide future support scope particularly with large domestic capital market development strides. Even with broad exchange rate depreciation few countries have been forced to raise interest rates and export competiveness has improved on the shift. The post-May fund retrenchment was within normal historic volatility and Japanese investors have increased diversification the last few months especially into Mexico and East Asia. “Secular forces” of integration and liberalization will drive the medium-run story and company valuations are again cheap by standard measures notwithstanding earnings and ratings setbacks. Average P/E ratios at 10 are at a sharp discount and external corporate and sovereign yield spreads are up 50 basis points since the Q1 bottoms.
By region Asia is almost half of inflows but current account worries in India and Indonesia spurred caution, while the rest of ASEAN and Korea held their ground on better risk prospects. In the latter foreign investors shifted from bonds to stocks as auto and electronics exports rose. In Central Europe local debt exposure at one-third of the total dipped slightly, and Russia and Turkey had pronounced bank borrowing reverses. Turkey’s refusal to hike conventional interest rates and reserve drain to bolster the lira have prompted exit and Ukraine with high fiscal and balance of payment deficits and an “unsustainable” currency peg urgently needs to renew its IMF program, according to the survey. Latin America outside Argentina and Venezuela is still attractive with fixed-income strength intact as Brazil has lifted former capital controls and taxes. In Mexico big M&A and IPO transactions have lifted sentiment, and in Colombia and Peru authorities have reduced exchange rate intervention. In the Middle East/Africa Egypt and South Africa have been shunned on political and budget slippage benefiting in contrast Nigeria and the UAE as their thrill ride accelerates, the document concludes.
