Fund Flows

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The Fed’s Liquidity Inflow Lament

2020 September 21 by

Pre-pandemic historically, aggressive US Federal Reserve loosening – cutting rates to record lows along with balance sheet expansion – drove investors into emerging markets debt, equity, and currencies in search of yield.  Even after the massive stock and bond selloffs during the GFC and the 2013 “taper tantrum,” fund flows into emerging markets returned within months seeking assets in faster growing economies and offering better returns than in the US and Western Europe. Conversely, a surprise rate hike in the US in 1994 sent funds fleeing emerging economies, resulting in massive foreign portfolio outflows pressuring currencies with some experiencing balance of payments crises. For example, Turkey with inflation running at 150% and a current account deficit of 3.5% of GDP, had to turn to the IMF, while that year ended with the Mexican peso devaluation induced “Tequila Crisis.”  In the mid-1990s, the universe of liquid, “investable” markets was limited, and the peso crisis spread as the relatively small number of dedicated EM investors fled, particularly throughout Latin America.

Today even with central bank benchmark rates in the US, UK, EU and Japan either at rock bottom or negative and as the G-4 monetary authorities massively expand their balance sheets, up by some USD 6 trillion collectively since the start of the Covid crisis, inflows to emerging markets remain subdued. While many stock and bond markets and currencies have rebounded since the sharp early year sell-off, investor commitments to EM remain muted and selective. The MSCI EM Index is up more than 30% from its March low, while the average yield on JPMorgan’s local currency government bond index has fallen nearly 2%.

Economic and financial market crises in global markets have historically resulted in EM central banks hiking rates to stem portfolio outflows and to avoid the associated spike in inflation w currency depreciation. The pandemic has upended the traditional response.  Instead of tightening, monetary authorities have not only slashed rates in an attempt to soften the economic impact of the pandemic, led by Turkey with 1,575 bps. in cuts the twelve months, but some have also turned for the first time to “quantitative easing” unconventional policies.  For example, central banks in Indonesia, Poland, and South Africa are buying government bonds, while their counterpart in Colombia is supporting the corporate bond market.

Through mid-August, emerging market equity funds have recorded outflows of USD 42.2 billion while bond fund outflows top USD 21 billion, according to fund tracker EPFR Global.  The Institute of International Finance, which tracks the 25 largest emerging markets, reports that inflows have rebounded unevenly.  After a record USD 83.3 billion was pulled from EM stocks and bonds in March, net inflows were recorded in June and July, with nearly 90% of the funds directed towards bonds.  Emerging market equity exchange traded products ( ETFs), which account for half of allocation, recorded $2 billion net inflows in July for the first time since January,  while flows to ETF debt products have been “overwhelmingly” directed to hard currency bonds since money began to tentatively return in April, according to iShares. 

As has been the case following every global or EM crisis for decades, the rebound in fund flows  illustrates the changing weight of benchmarks against which to measure fund performance and intense investor scrutiny of debt, deficit, currency, and foreign exchange reserve levels.  China, viewed as “first in-first out” of the Covid crisis, accounts for 20% of the MSCI Emerging Markets Index.  As its economy shows mixed signs of recovery with a relatively stable currency against the greenback and it was added to major bond indices, China has attracted USD 66 billion to its local bond market this year, almost equal to total inflows in all of 2019.  In contrast, Turkey has seen total portfolio outflows of over USD 12 billion this year as the central bank drained FX reserves to try to support the currency before letting it depreciate this month to new record lows. The country’s benchmark index positions are increasingly marginalized, as foreign investors now hold only USD 26 billion in local stocks and bonds, the latter with negative real yields with inflation running over 11%. 

The global pandemic crisis is the first in which both emerging and developed economies are projected to contract. In the wake of the GFC, global GDP was -1.67% in 2009 but emerging markets grew 2.6%.  This year the IMF expects global growth at -4.9%. However, emerging economies are expected to shrink less than advanced ones with a stronger rebound in 2021.  The IMF’s most recent projection is for the former to contract 3% and rebound 5.9% in 2021, while it expects the latter at -8% and + 4.8%, respectively.  As Covid-19 rages, investor re-engagement and a rebound in fund flows to emerging economies will remain subdued in the near-term. Hard and local currency bonds from “safer” investment grade sovereigns and corporates, will lead the rebound. Listed equities in emerging economies, both domestically oriented firms and exporters, will continue to struggle to attract foreign investors on poor virus and cycle bottom earnings.  Double-digit unemployment will spread, while global trade is projected by the IMF to fall at least 10%. Even doing “whatever it takes,” as the ECB promised during the  height of the Eurozone crisis & implied again early this year, the US Federal Reserve and advanced economy counterparts can no longer in lockstep reignite global growth or fund flows to emerging markets.

Portfolio Contagion’s Immature Immune Response

2020 April 23 by

The physical coronavirus’ global explosion was matched in market results and fund flows with the initial blow, with currency, debt and equity indices down double digits, and combined two-month January-March outflows over $40 billion, double the 2008 financial crisis total according to the IIF headline tally. Public and private sector economists scrambled to revise already sober GDP growth forecasts to consensus recession, as the UN postulated a “doomsday $2 trillion hit” for a barely positive 2020 finish. China as the outbreak source was the first to report the scale of simultaneous demand and supply destruction, with fixed asset investment and retail sales both off 20%. S&P Ratings expected further “downside risks,” and the IMF Managing Director Georgieva after an original 3% projection could not define the “far fall.” The parallel oil price collapse with Russia and Saudi Arabia refusing output cooperation was another wrench, with a one-day 30% drop to $25/barrel the biggest in three decades. Big importers in Asia and elsewhere would typically benefit from the move especially if it tips the current account balance, but the likely Covid-19 fallout will negate these effects. The IMF and World Bank jumped into the breach, with respective $50 billion and $15 billion pledges for the disease emergency. Iran, with the largest caseload in the Middle East, asked the Fund for $5 billion for the first time since the 1960s. The US has not relaxed its comprehensive sanctions which exempt humanitarian operations, and it or another country could also block help due to internationally-certified noncompliance with anti-money laundering and terror financing rules. Venezuela was another unusual case seeking to tap the special rapid facility, but the request was rejected on the Maduro government’s non-recognition.

In advanced economies the big guns mobilized unprecedented rate-cutting and bond-buying programs. The Federal Reserve in a rare inter-meeting action slashed the benchmark to near zero and rolled out massive Treasury and other instrument backing. New ECB chief Lagarde after first demurring unveiled a euro 750 billion Pandemic bond purchase expansion, and the Bank of Japan deepened forays into corporate as well as government offerings. Washington extended swap lines with Canada, the UK, and Switzerland as well as into select emerging markets like Korea. China reduced bank reserve requirements twice, and Brazil, Indonesia and Turkey cut rates and intervened in currencies for “smoothing” purposes. Asia as the regional epicenter introduced large fiscal stimulus packages beyond China/Hong Kong. Indonesia offered $10 billion in manufacturing tax breaks and small business loans. Brazil chipped in with $30 billion repurposed from the existing budget, despite President Bolsonaro’s flagrant repudiation of recommended social distancing as he organized political rallies. In Europe Poland and Turkey deferred pension charges and expanded health and infrastructure spending, as the EU created a $35 billion pool and vowed more convergence criteria flexibility due to the catastrophe.  This largesse in turn could accelerate exchange rate depreciation against the dollar, with 20% drops for oil exporters in particular, including Mexico and Russia, Mexican President AMLO has also been widely criticized as a virus doubter as he insists on close embraces with government officials and supporters, while Pemex and the sovereign struggle to stave off ratings downgrade spread.

Debt Flows’ Cascading Crimp

2019 September 6 by

Emerging market local and hard currency debt flows over $50 billion continued to swamp negative equity ones into August, and looked for year-end direction as retail investors unloaded in the wake of the Chinese devaluation-manipulation saga and Washington’s 10% across-the-board tariff surcharge. It will dent growth around half a point and ricocheted through Asian trade partners and Latin American commodity exporters in particular, with Europe otherwise occupied by flat expansion and inflation expected to spur new ECB chief Lagarde into more asset buying. Only one-tenth of the debt exposure has been domestic with the strong dollar and global central banks led by the US Federal Reserve on a rate-cutting spree. ETF exposure has been modest at $5 billion, and strategic holders like insurers and pension funds remain committed. They have yet to reposition for extended monetary and commercial conflict, and external sovereign and corporate technicals were favorable before the blowup. On the former over $110 billion has been placed on pace for $150 billion in total, with the Gulf a core segment after joining the EMBI benchmark. The latter has tripled that volume on the way to a $400 billion finish, with July unusually busy and Asia still half the field. Tenders and buybacks continue strong with a $50-75 billion estimate by December. However with the US Treasury yield falling on easing and safe haven purchase valuations are arguably stretched with both gauges’ spreads around 300 basis points. The EMBI’s gap shrank with Venezuela’s removal after extended notice, and with announcement of a full bilateral embargo American holders are stuck with dud paper until an eventual restructuring with a successor government. Russian traders are active but liquidity is absent, and they in turn are worried about additional Washington sanctions outlawing primary sovereign subscription in response to chemical attacks on London-based Kremlin enemies. Marking two decades in power, President Putin also faces stagnant growth and doubled consumer borrowing as protesters take to Moscow’s streets demanding fair municipal elections. Corporate fund managers prefer Russian names with investment-grade ratings, but have turned defensive on commodity credits in particular.

Around China upset also focuses on Hong Kong, in literal lockdown as the police and democracy campaigners fight it out despite Beijing’s withdrawal of a controversial extradition law. Thirty years after the Tiananmen events, the army could be called out to subdue unrest, which has already prompted international travel warnings to the popular shopping and re-export hub. Growth could be erased in the coming months, as stratospheric property values supporting the budget surplus come under pressure with potential exodus. The dollar peg has not come under sustained speculation, but the Yuan is half the intervention basket and serious greenback realignment will force difficult choices. From a financial market standpoint, analysts point out that with the launch of Shanghai’s new tech startup platform to complete the multi-trillion dollar complex Hong Kong’s claim is not as secure as an overriding caution against crackdown. In India as well, local debt holders after Prime Minister Modi’s sweeping reelection were spooked by threatened new taxes and Kashmir’s takeover, with Pakistan vowing to answer with the subcontinent again on a delicate fiscal and nuclear timer.

Fund Flows’ Record Reset Rumblings

2017 August 29 by

EPFR-tracked fund bond and equity inflows were at record-setting pace through August, at $70 billion and $50 billion respectively, with numbers due to match 2012, before the Fed Reserve’s taper tantrum blow. Including so-called strategic allocation through separately managed accounts, the former category should exceed the $105 billion total five years ago, as non-dedicated investors have jumped in to join retail appetite reflected in unprecedented ETF preference. Local currency still lags hard currency interest, continuing recent annual trends, but could catch up by end-year as dollar correction persists after its initial lift on Trump reflation and protectionist policy agendas. By the same token external corporate and sovereign exposure is increasingly converging as gross issuance reaches estimated $400 billion and $150 billion sums in 2017, at spreads over US Treasuries in the 250-300 basis point range. Fixed-income index returns average high single-digits, but lag stocks with the benchmark MSCI soaring 25 percent with the P/E ratio at 14 times. In the detailed EPFR breakdown one-quarter of participation is through ETFs and global as opposed to regional or country funds dominate. North American and European investors eagerly subscribe the offerings, while Japanese ones shy away. The data show a heavy tilt toward consumer goods and technology in contrast with financial and commodity listings, and dividend as well as capital gain strategies. Company profits will increase over 10 percent on a forward basis due to better management and margins and the growth uptick to 5 percent in Q2 on China stabilization and positive trade volume after restriction threats. Brazil, Russia and South Africa are back from recession, and inflation is subdued across the universe with food and fuel costs relatively constant as exchange rates strengthen. Against this background, few central banks will raise interest rates with the vast majority staying on hold or easing marginally.

However the BRICS and other core markets have not shaken off political risks that combine to act as a potential future drag. Brazil has avoided a second impeachment for now with a vote not to remove President Temer despite bribery accusations, as his predecessor Lula was found guilty of these charges and sentenced to a long prison stretch he will appeal. Finance Minister Mereilles promised to press on with social security reform after the decision, but the constituency for fiscal discipline is thin and wavering heading into another election cycle. Russia was subject to additional US energy and individual sanctions, after Congress almost unanimously passed legislation over President Trump’s objections that it interfered with executive foreign policy determination. Moscow retaliated by ejecting half of Embassy employees, as Russian shares continue to be an exception with a 15 percent decline through July. Poland has led the regional pack with a 40 percent jump, but the EU is considering penalties under Article 7 for anti-democratic action as the government assumes sweeping power over the nominally independent judiciary. The Brussels backlash follows similar signals against Hungary, another stock market high-flyer, for the Orban administration’s anti-migrant steps, including alleged abuses in detention and residential facilities. The “nuclear option” in both cases would be cohesion fund cutoff, equivalent to 20 percent of GDP, at the same time the world is facing the actual prospect in North Korea with the specter of literal Asian fallout.

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Private Equity’s Public Preference Probe

2017 June 3 by

The latest EMPEA trade association annual survey of over one hundred  private equity institutional investors with $500 billion in dedicated global assets averaging one-fifth in emerging markets offered mixed sentiment, as dollar levels are due to rise while allocation size in the overall  portfolio shrinks. While developed market exposure continues to rise in contrast, bigger managers with $10 billion or with a decade or more experience are more likely to increase the relative share. Private pension funds will forge fewer general partner (GP) relationships while development lenders plan to extend them with at least five new ones, as both groups stress operating savvy rather than buyout approach as their main selection factor. Co-investing and deal by deal structures are important and local currency returns are no longer the decisive benchmark in light of recent volatility implying resort to hedging strategies. India is the number one preferred destination and attracted $8.5 billion the past two years, Southeast Asia is in second and Latin America ex-Brazil took third as almost 20 transactions were completed in Argentina after a long drought. Sub-Sahara Africa beat out China, which takes one-quarter of capital deployed, and Russia and Turkey were at the bottom of the heap. Brazil’s standing rose but 15% of respondents will cut or end involvement there with continued political upheaval despite economic stabilization and growth return. By industry consumer goods and healthcare were the runaway favorites, with the former attracting $25 billion in 2015-16. Although half of investors complained about lack of exit and fund distribution, only 15% are considering secondary sales for cash and liquidity as they await efficiency and transparency improvements. Currency risk topped the list of macro concerns after the dollar’s recent surge erased local unit gains, and GP team stability was the chief operational one, especially with regular talent poaching and spinoffs from original vehicles reshuffling personnel. While 70% of limited partners polled thought their portfolio performance met expectations, only a minority still believe the previous 15% desired annual return is in reach. They assume developed markets will continue to lag and tap Asian funds as the top prospects, while Europe/MENA and Russia-Turkey offerings are not likely to gain 10%.

Sponsors have looked to Gulf sovereign wealth pools for anchor money, but with Saudi Arabia’s $20 billion commitment to a Blackstone infrastructure fund announced during President Trump’s trip there for an Arab summit, PE attention has turned to possible local deals that could be targeted in the mandate. The stock exchange was down through April on the MSCI index, but public capital market development is a core component of the 2030 plan’s modernization push, with equities to be further opened to foreign investors who currently account for 5 percent of activity. The June index review may position the bourse for an upgrade from frontier status, amid preparations for an historic IPO by oil and non-oil behemoth Aramco awaiting sensitive balance sheet and government relationship disclosures that may not satisfy global asset manager demands. They are otherwise dubious of reform intentions to stoke 1 percent GDP growth, expand private sector share, and restrain the budget deficit after civil servant allowance reinstatement and a new housing and debt restructuring stimulus package estimated at tens of billions of dollars over the near term without a convincing exit strategy.

 

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Sovereign Wealth Funds’ Somber Secrets

2017 May 5 by

The latest sovereign wealth fund (SWF) profile from tracker Prequin, after a decade of following the industry, shows assets largely flat at $6.5 trillion across 75 vehicles. The ten largest control 80 percent of the total, led by Norway with $835 billion and smaller ones in Malaysia and elsewhere have combined for scale. Hydrocarbon earnings provide over half of capital, with the Abu Dhabi and Kuwait Investment Authorities main representatives. Asian countries with large trade surpluses, headed by China, are the other 45 percent and non-energy commodity producers account for just 1 percent of the field. Traditional public equity and fixed income asset classes are in the portfolios of 80 percent of participants, and Ghana and Peru completely allocate to bonds. Private debt and equity also draws a majority, and over half are in alternatives like real estate, infrastructure and natural resources with Kazakhstan and Angola among the examples. Hedge funds are another strategy and take one-tenth of global institutional money there, but their short-term nature and illiquidity limit popularity. Equity engagement can be designed to support the local stock exchange as in Taiwan’s case and Venezuela is rare in having no such exposure after controls forced its market out of the MSCI index. Distressed loans are the chief private debt class, with European banks with EUR 2 trillion on their books the prevailing source. According to consultants Price Waterhouse the SWF definition meet basic criteria, including a clear mandate as a financial passive investor; an autonomous structure to counter the resource “curse” and fiscal imprudence; and distinct governance and operation apart from the government in power. Funds nonetheless can come under official interference and pressure despite nominal independence and protection, as with requests to Brazil’s and Nigeria’s startups to aid the budget and currency and the transfer of post-coup try nationalized companies to Turkey’s.

Turkey’s delegation to the IMF-World Bank spring meetings downplayed such concern and presented President Erdogan’s razor-thin referendum win on constitutional changes as a political stability sign. The next national elections are scheduled for 2019, and the Syrian border situation is calmer with greater territorial control. The GDP growth forecast is 4 percent, and the inflation burst from lira depreciation should recede to manageable single digits with monetary tightening. Externally, the current account gap should remain constant and debt rollover ratios for private companies are above 100 percent, although large holes exist in the balance of payment errors and omissions column. The structural reform agenda, which initially included private pension promotion, will be reactivated in the wake of the plebiscite and concentrate on better public finance management and other higher efficiency areas.  Russian representatives likewise cast Western sanctions and diplomatic tensions as a secondary issue, and dismissed recent renewed street protests as a challenge to President Putin’s rule. The ruble has firmed with rising oil prices, and the next budget will be disciplined based on a $40/barrel level. Tax shifts increasing VAT and reducing the payroll levy to tackle informality are in the works, and with good inflation and currency readings the central bank is in gradual rate reduction mode as supervisors continue to clean up the banking system. The deputy governor continues to win international praise for her technocratic deft touch, and was featured on a flagship “emerging market resilience” panel at the Fund meetings amid shaky geopolitics.

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The IIF’s Capital Flow Vertigo Trance

2016 April 25 by

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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Bond Flows’ Wistful Weave

2016 April 19 by

Fund tracker EPFR reported $100 million in net bond inflows at the end of Q1 snapping a long losing streak, with $3.5 billion in hard currency allocation clipping almost the same amount of local currency flight. ETFs were the sole positive category with dedicated US, Europe and Japanese funds shedding exposure, but performance was in stark contrast to equities’ $7.5 billion hole for the period. Pure corporate topped sovereign commitment as the benchmark external indices were up on average 5 percent, half the local bond gauge gain in dollar terms. Additional industrial economy monetary easing and pausing helped drive currency results to a 3-year high as dollar strength eroded. Commodity exporters enjoyed the biggest bounce as oil recovered 50 percent from recent lows. The trade-weighted dollar was down 5 percent as the Chinese renimbi firmed under its new basket peg, and asset class underweight positions drifted toward neutral despite sketchy fundamentals. GDP growth forecasts were again reduced in private and official analysis, and commercial debt overhangs linger in major markets. The Institute for International Finance’s April capital flow survey predicted outflow shrinkage from last year but a still hefty $500 billion retreat. Sovereign ratings downgrades were the worst in a decade with a dozen in the first quarter, as the EMBIG Diversified fell below investment-quality for the first time in five years. Inflation moderated to the 4 percent range but developing country central banks will not loosen monetary policy more than marginally. The index spread compressed 100 basis points in March with $30 billion of gross issuance against a full-year prediction around $100 billion. International corporate placement came to over $45 billion but was one-third off 2015’s pace. Asia continues to dominate, but Latin America crept back with a flotation by Argentine state oil giant YPF amid buoyant post-election sentiment and Gazprom returned as a Russia stalwart despite sanctions.

Heading into the Inter-American Development Bank annual meeting in the Bahamas, regional debt readings were subdued as Moody’s put Mexico on negative outlook with fiscal deterioration from Pemex’s tangled budget and private partner transition. Industrial production and services show opposite patterns for lackluster 2.5 percent GDP growth, as the central bank lifted the policy rate in February to stem peso weakness. Brazil’s unending political saga and recession evoked an impeachment-driven rally as the core PMDB party left the ruling coalition and the Congress begins voting to remove President Rousseff. Improved currency and inflation levels could allow SELIC rate cuts in the coming months and relieve the burden of state obligations to the federal government that will be refinanced under a March proposal. The negligible primary surplus target was further flattened to under 0.1 percent of GDP despite the promise of official spending caps. In the Andean region Colombia’s current account gap will again approach 6 percent of output on lagging oil exports and portfolio inflows. Privatization of electricity generator Isagen should bring in $3 billion but foreign investor enthusiasm remains dented from stalled tax reform and rebel guerilla peace deals. Headline inflation at 7.5 percent is double the target zone. The ELN has just joined the FARC in demobilization talks, and settlement runs the risks of rejection in national voting and heavy immediate fighter compensation and training costs unleashing another sovereign downgrade wave.

Capital Flows’ Quality Deterioration Qualms

2015 June 5 by

The IIF’s May reading of private capital allocation to 30 markets reduced this year’s projection to below $1 trillion for a post-financial crisis low as Q1 economic growth was just 4 percent and inflows/GDP at 3.5 percent were the worst since 2002. Next year after Fed rate hikes and possible abatement of geopolitical standoffs as in Russia-Ukraine the total should recover to $1.2 trillion, but a “stress event” can still be envisioned and amplified with the lack of secondary trading and high corporate debt. Portfolio investment has been volatile in recent months and $10-15 billion in outflows accompanied the German bund “mini-tantrum” despite the ECB’s $50 billion buying program. Equity commitments will rise 20 percent from 2014 to $130 billion on discount valuations versus mature markets, while fixed-income stays flat at $170 billion. FDI will decline 10 percent to $530 billion chiefly from China and Russia pullback. China alone will send that amount outward in the form of official reserve recycling, commercial investment and repayment, and capital flight as the other tracked economies send an equal sum abroad for a $1.2 trillion total. Russian money exit slowed to $25 billion in the last quarter as the ruble firmed and companies covered external obligations with central bank aid.

Global growth may pick up slightly in 2016 under benign assumptions of gradual Fed rate hikes and firmer commodity prices which allow healthy consumption and exports. However sudden US wage pressure with skilled positions hard to fill could be a negative surprise affecting all asset classes with sudden risk aversion, and especially large current account deficit countries like Brazil, South Africa and Turkey. This shock would come against a background of dwindling reserve accumulation, with a wide swathe of Asian, European and Latin American borrowers below the 1-year short-term debt coverage standard. Corporate hard-currency bonds outstanding are over $1 trillion and the previous tendency to issue 70 percent in local currency has eroded over time. Cross-border bank lending also hit $3 trillion in 2014 according to the BIS as non-EU groups replaced weak Eurozone providers with geographic and historic links. With almost $400 billion due in both categories through 2017 consumer and real estate firms without natural hedges are likely most vulnerable, but derivatives markets otherwise are thin with exceptions like Korea and Mexico. Secondary turnover is particularly lacking as US dealers alone slashed foreign bond inventory two-thirds due to post-crisis capital and proprietary dealing changes. Local currency corporate market-making is only $45 billion out of a universe of $5.5 trillion and many pension and insurance funds that own the paper are locked-in buyers anyway, the survey asserts. ETFs have expanded into the space to attract both retail and institutional investors, and their “herding behavior” and untested liquidity on large scale redemption could pose additional threats.

In Asia China is expected to further open the capital account to gain IMF SDR basket inclusion and foreign fund manager confidence, but Indonesia and Malaysia with 40 percent range overseas ownership of domestic government bonds may be under siege as India’s structural reform rollout leaves the one-year old Modi regime “better placed.”  Greek euro exit could taint the neighborhood, and Latin America is “still in the game” with even Argentina poised for a private capital turnaround with President Fernandez’s departure. The Middle East-Africa will be whipsawed by lower commodity values as Gulf foreign assets drop $100 billion to cap the cross-continent gusher.

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The BIS’ Claim Filing Clamor

2015 May 29 by

The BIS’ lagged cross-border emerging market banking claims tally for the last quarter of 2014 showed another drop to below the $4 trillion mark as the global total also fell for Asia and Europe in particular. The period represented a second successive drop as seen previously during the Fed taper tantrum and 2008-09 crisis, but systemic damage was not posed as flows to Latin America and the Middle East/Africa rose to almost $1 trillion combined.  China alone had the same amount in outstanding lines, and associated Hong Kong accounted for another $400 billion while India was far behind at $200 billion. Europe was off $50 billion to $725 billion, half due to Russia’s sanctions but also to euro depreciation against the dollar. Latin American exposure is up post-crisis especially to Mexico, but Brazil at $250 billion remains the largest recipient. In the Mideast Saudi Arabia attracted $75 billion but local bank liquidity obviates external borrowing, according to the study.

The statistics focus on short versus long-term and bank against non-bank activity with Asia the outlier in both riskier measures. The bank claim portion is close to Developed Europe’s 45 percent and 70 percent are under one-year maturity. Along with China, Korea and Singapore are concentrated in that bucket. Regional lending at 15 percent of GDP is one-third the peak during the 1990s financial crisis, and the Chinese spurt may have been due to currency carry trading as well as trade credit and invoice manipulation. Russian participation in contrast is in the non-bank private sector and net redemptions have lowered the total to $125 billion. In advanced economies it continues to shrink from $25 trillion pre-crisis to $20 trillion at the end of last year, with the UK, France and Germany each over $1 trillion and Japan just below that number.

Current EPFR bond fund data in turn reflects $500 million in weekly allocation since March with three-quarters in hard currency. Retail and institutional investor participation through May is around $15 billion by broader industry estimates, and local and external sovereigns are 80 percent together in portfolios as compared with corporates’ 20 percent. Sovereign gross issuance is over $40 billion over one-quarter euro-denominated, and on a net basis the remaining 2015 pipeline will be flat. The foreign corporate equivalent is $125 billion, behind last year’s pace, with quasi-sovereigns half the sum and 80 percent investment-grade rated. Asia accounts for two-thirds of placements, and the six-month Brazilian drought was just broken in the wake of Petrobras’ belated earnings release.

Brazil’s sovereign rating may be saved from demotion with the Petrobras disclosure and fiscal adjustment plans, but recession will likely impede return to primary surplus targets. India has been an overcrowded position as oil price rebound may hurt the current account deficit and inflation trajectory. Land and tax reforms are still stuck in parliament and state banks with large nonperforming infrastructure loans need recapitalization soon. Indonesia’s Jokowi was originally cast in the Modi game-changer mold but has since disappointed with populist economic policies and crony appointments demanded by his broader political affiliation. After cutting fuel subsidies, macro-prudential curbs in consumer loans were lifted to honor party claims.

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