The Hindu Business Line : Private capital flows to emerging markets dip

"This could be a critical year to restore confidence and rebuild the investor base if there is a strengthening of the overall global economy and, even more importantly, if there is firm evidence of sustained sound macro-economic policies and structural reform across the emerging market economies", according to the IIF Managing Director, Mr Charles Dallara.

PUNE, Feb. 13

NET private capital flows to emerging market economies continued to retreat last year, down from $125.7 billion in 2001 to $112.5 billion. The 2001 figure was the lowest in a decade, significantly below the 1990s average of $185 billion.

The Institute of International Finance (IIF), the global association of financial firms representing 320 financial institutions, says that a modest improvement in these capital flows to about $137.1 billion is anticipated in the current year.

According to the IIF Managing Director, Mr Charles Dallara, investors remain reluctant to increase their commitments to emerging market economies. He has pointed out that "weak growth in the major industrial countries and geopolitical concerns have combined with an erosion in investor support for the emerging markets asset class."

Asia-Pacific is seen as attracting net foreign direct equity investment of $55 billion this year after about $52 billion in 2002. The IIF has noted that China alone accounted for over 85 per cent of last year's total and that the country experienced a strong WTO-related increase in direct investment that is expected to continue into 2003.

Stepped-up privatisation boosted net inflows of direct equity to emerging Europe last year to nearly $17 billion, and the IIF forecasts the 2003 total at $16 billion. Net direct equity investment in Latin America fell to $36 billion in 2002 from $55 billion in 2001, and it is projected to decline to $34 billion this year.

Further, the IIF has reported that the 2003 projected increase in net private capital flows rests on expectations of continued global economic recovery, albeit a modest one. It also assumes some improvement in the economies of Latin America and an easing in oil prices in the second half of 2003, after a rise in the first half, as West Asia tensions are expected to subside.

According to Mr Dallara, "notwithstanding the important progress that has been made in a number of important economies, we have witnessed the declining appetite of investors for the emerging markets asset class since the series of crises that began in Mexico in 1995."

"The momentum of structural reform and privatisation has slowed in a number of countries, which has further eroded investor sentiment." In addition, the IIF First Deputy Managing Director and Chief Economist, Mr Yusuke Horiguchi , has said that "the new data indicates increasing differentiation by investors between different countries and regions with rather limited contagion evident from crisis countries, such as Argentina." "The differentiation is positive evidence of improving investor risk management. It suggests that implementation of sound policies in emerging market economies will meet with favourable market responses."

According to the institute, economic growth in both Asia and emerging Europe is likely to continue this year at levels close to those seen in 2002, with Asian growth of just above six per cent far outpacing other regions. The IIF forecasts that output in Latin America is likely to stabilise and improve slightly after its extremely poor performance in 2002.

Emerging market portfolio equity investment has been at very low levels in recent years, but a modest uptick to $9 billion is expected for 2003 after net outflows of nearly $5 billion in 2002. Overall, emerging stock markets saw declines in 2002 of just under five per cent in US dollar terms.

Particularly hard hit last year were equities in Latin America, which dropped by close to 26 per cent, as the crisis in Argentina and volatility in Brazil and Venezuela shook confidence.

The IIF has stressed that non-bank flows of capital (mostly bonds) were severely depressed during the last two years. Excluding the ongoing accumulation of interest arrears in Argentina, which are counted as a capital inflow in balance of payments data, net non-bank flows are seen as reaching $16 billion this year after $12 billion in 2002, compared to an annual average volume of about $44 billion over the last decade.

In a special section in the IIF's new report on bond flows, the Institute has stated that the 2002 and 2003 volumes are lower than at any time since 1990 as new disbursements have fallen relative to repayments.

According to Mr Horiguchi, "although credit flows are unlikely to experience further contraction and are likely to stabilise as the global economy gains momentum, we expect that it could be several years before emerging market bond flows are restored to the significantly higher levels that were seen during the 1990s."

The IIF has further pointed out that net repayments to commercial banks are expected to continue this year, although at a more modest rate than in recent years.

In part, the overall trend of commercial bank lending to emerging markets of recent years reflects a continuing shift by internationally active institutions from new lending for their own balance sheets to fee-based activities, in part due to improved risk-management methods.

Moreover, international commercial banks are also playing an increasingly active role in local currency lending rather than external financing.

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