The IIF’s Capital Flow Vertigo Trance

The IIF shed early year gloom but referred to a continued capital flow “roller coaster ride” for the 30 countries its survey tracks, with the net outflow projection shaved to $500 billion from $750 billion last year as non-resident allocation turned positive in March. Equities are up 25 percent from the 2016 bottom and local currency bonds have regained favor with dollar plateauing, but the rebound may be due to general risk sentiment rather than specific economic improvements. Chinese renimbi and oil price stabilization and looser European and Japanese monetary policies have contributed to recovery, along with isolated stories like a decent budget in India and market re-entry with a record $15 billion bond offer in Argentina to pay holdout creditors and cover the fiscal deficit. Valuations and investor positioning were at extreme lows in January, with sovereign bonds offering yield pickup over zero and negative industrial country returns, and a 10 point difference in cyclically-adjusted price-earnings ratios between emerging and mature markets. However in external corporate bonds the discount argument is less compelling versus US high yield, especially with the amount outstanding touching 100 percent of GDP. Currencies may still be undervalued in real effective terms and volatility has also declined in recent months as an exposure argument. The outlook assumes the Federal Reserve will stay cautious on rate increases in light of global economic lethargy, reflected in IMF and World Bank growth downgrades during their spring meetings. Non-resident private inflows should more than double to $550 billion from 2015’s $250 billion, the worst in a dozen years. China and the rest of Asia in particular should experience a turnaround, but both FDI and bank lending will soften for all regions and Russia, Turkey and Ukraine will get $10 billion less than originally forecast. The combined current account surplus will fall from $265 billion to $220 billion as Asian and Gulf exporters lose reserves at a “more manageable pace.” Euro area banks have retrenched from developing markets and international claims are down 10 percent since 2014 to around $3 trillion, with only Japanese loans rising. In Q1 syndicated activity was off 50 percent from the same period last year, and the IIF’s conditions index shows further tightening below the 50 level.

A separate section looks at Chinese reserves “great unwinding” which accelerated in 2015’s second half with a $425 billion drop.  The main contributors were company dollar debt repayment and offshore Yuan deposit shrinkage, but unrecorded transactions in the errors and omissions account were also notable. FDI remained positive in that period at $150 billion, but portfolio debt and equity numbers were negative. Cross-border loans and deposits each were off $100 billion, often coming through Hong Kong subsidiaries of mainland banks. Foreign liabilities remain $1.4 trillion according to official statistics often in the form of trade credit, and Chinese individual and corporate outward investment further swelled under the One-Belt One-Road program and personal savings access up to $50,000 annually. Export-import discrepancies came to $700 billion in trade data with under-invoicing still widespread. The analysis concludes that even with an additional slide to $3 trillion, reserves would be sufficient to cover short-term obligations and defuse serious currency depreciation according to IMF measures, despite another loop on the gravity-defying journey.

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