The recovery in EM capital flows stalled last month, but this is only a minor setback – net outflows were very small. The main culprit appears to have been softer foreign demand for EM equities, with appetite for bonds continuing to strengthen. If we’re right that global risk appetite will improve in the coming months, net capital outflows from EMs should remain modest.
- The recovery in EM capital flows stalled last month, but this is only a minor setback – net outflows were very small. The main culprit appears to have been softer foreign demand for EM equities, with appetite for bonds continuing to strengthen. If we’re right that global risk appetite will improve in the coming months, net capital outflows from EMs should remain modest.
- Our total EM Capital Flows Tracker, which is constructed using monthly trade and FX reserve data, gives clients an early read on capital flows ahead of the release of official balance of payments data. (Details available on request.) The monthly version of our Tracker is shown in Chart 1.
- To recap, according to our Tracker, net capital outflows spiked to around $55bn at the height of the crisis in March, before recovering strongly in April. In May, we estimate that outflows and inflows pretty much offset each other. The improvement in EM capital flows appears to have stumbled last month, with net capital outflows resuming. That said, the size of net outflows was very small, at around $15bn.
- Daily data suggest that net portfolio flows may have softened a bit further so far in July. Figures on non-residents’ net purchases of equity and bonds are not directly comparable to our Tracker, not least because they are only available for a handful of countries, but they do help to give a sense of direction. Foreigners have turned from net purchasers, to net sellers, of EM assets in recent weeks.
- This shift appears to have been driven entirely by a drop in external demand for equities. In contrast, foreigners’ net purchases of bonds have continued to recover. (See Chart 2.) It’s difficult to determine exactly why this is. But one factor supporting inflows into bond markets might have been expectations of further monetary policy loosening in EMs and relatively stable currencies.
- The key near-term risk to EM capital flows is a re-imposition of national lockdowns in major global economies (notably the US), which could trigger another drop in activity and dislocation in financial markets. But even then, the pace of net outflows would probably be limited. Indeed, even at the height of the crisis, the pace of outflows was modest. There are a number of likely explanations but one of the most important is that FDI and banking sector flows seem to have been relatively resilient.
- At the same time, one consequence of very depressed activity in EMs is that current account deficits are likely to have narrowed in many countries, reducing reliance on capital inflows to finance domestic spending. So while portfolio flows are likely to swing with the vagaries of risk appetite, few major EMs look vulnerable to a period of destabilising capital outflows in the coming months.
- One exception is Turkey, where the current account deficit has widened sharply in recent months as tourism receipts have collapsed and policymakers have tried to shore up activity by pumping the economy with credit. A recovery in tourism receipts should narrow the current account deficit over the coming months, but Turkey will remain one of the most vulnerable major EMs to balance of payments strains.
Chart 1: CE Total Capital Flows Tracker
Chart 2: Foreigners’ Net Purchases of Bonds & Equities
Sources: Refinitiv, Capital Economics
Edward Glossop, Senior Emerging Markets Economist, +44 (0)7896064878, email@example.com