Private capital flows will remain strong, says Institute of International Finance

By Reshmi Basu

New York, March 31 - Private capital flows into emerging market economies will continue at a robust pace, despite the recent market volatility in emerging market bond and stock prices, according to a report by the Institute of International Finance.

Since its January report, the agency has since upwardly revised its estimate for 2004 and the projection for 2005 to $303 billion and $311 billion, respectively, from $279 billion and $276 billion, in a report titled "Update on Capital Flows to Emerging Market Economies."

An acceleration in direct investment underlies the strength of the figures. The level now projected for 2005 is the second highest over the past 20 years.

In the last several months, the strengthening of flows into emerging markets is astounding given the tightening of U.S. monetary policy. Factors such as the continuation of the global economic recovery, increasing confidence in policy performance in key emerging markets, and until recently, the yields on 10-year U.S. Treasury notes have added support to flows, the report said.

Nonetheless, factors such as global interest rate risk, geopolitical tension and oil price uncertainties threaten the robustness of flows.

"However, there is a risk that the pickup in flows into some emerging market assets has pushed valuations to levels that are not commensurate with underlying fundamentals," the Institute said in the report.

A change in investors' perception regarding a number of key factors that have given support to valuations could indeed derail the momentum for a further increase in net private capital flows into the market.

Investors eye emerging markets

Investors' continued willingness to add emerging market bonds to their portfolio could help push net nonbank private sector lending close to $80 billion in 2005, the highest level since 1997. Higher credit ratings of emerging market issuers have led to the tightening of spreads since the latter part of 2002. But as spreads on emerging market bonds have recently widened from the record low set in March, an event such as a change to inflation expectations or a high profile downgrading could result in a sudden spread widening on high-yield U.S. corporate bonds, which will only add to investor consternation.

In the past three years, the higher credit quality in emerging markets and risk-adjusted returns has attracted a broader base of investors, the Institute reported. Leveraged money and trading accounts are no longer the primary players as long-term investors such as pension funds and insurance companies have entered the picture.

"For now, the supply of bonds coming on stream is likely to be readily absorbed as emerging market bonds remain a diversification play for institutional and crossover investors given the relatively low correlation with other assets," the Institute said in the report.

Issuance in the first quarter was at a record pace as many issuers jumped in ahead of anticipated higher global interest rates.

More euro-denominated deals seen

As the year continues, the number of euro-denominated shares will increase, reflecting the demand for paper from European institutional investors. Moreover, there will be more sovereign issues denominated in local currencies.

On a regional basis, emerging Europe is projected to account for nearly two-thirds of nonbank private creditor flows to emerging markets in 2005. The total projected amount is $37 billion, which is nearly nine times higher than the low point in 2002. Just like 2004, Poland, Russia, and Turkey will be the primary issuers in the region. Brazil will be the largest recipient of net nonbank private lending in 2005 as the government looks to speed up its borrowing program, which may issue the first real-denominated global bond.

Nonbank private lending into the Latin American regions is projected to increase $12 billion in 2005 from $10 billion last year.

And creditor inflows into the Asia/Pacific region is expected to drop to $12 billion from a record high of $16 billion in 2004 with China, Korea and Malaysia seeing a decline in net inflows.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.