Net capital inflows – FDI, portfolio and bank flows – to emerging market economies have slowed significantly since 2010, reports the IMF in its latest World Economic Outlook, published on the occasion of its 2016 Spring Meetings.
This has been a generalised trend, with all regions and three-quarters of the 45 emerging market economies studied being affected, with particularly sharp declines for China and Russia. Both commodity and non-commodity exporting countries have experienced slowdowns.
As the IMF notes, this is a matter of concern because capital flows can aid domestic investment and growth. What’s more, long downswings in the global capital flow cycle during the 1980s and 1990s were associated with a high incidence of debt crises.
Both declining inflows and stronger capital outflows contributed to the slowdown in 2010 to 2015, in contrast to the slowdowns in the 1980s and 1990s, which were mainly driven by slowdowns in inflows. And FDI and banking flows have been the largest components of both inflows and outflows, exceeding portfolio equity and debt flows.
“Residents parking money abroad has been an important factor behind these dynamics,” Luis Catão, senior economist in the IMF’s research department told a Washington, DC press conference. This can be motivated by different reasons.
For one, as emerging market economies are growing and becoming richer, local investors want to diversify their portfolios. This is evident in the growing outward FDI from emerging market economies, and the emergence of pension funds and sovereign wealth funds within them. And then there are also short-term considerations associated with concerns about macroeconomic vulnerabilities.
As for what factors have contributed to the slowdown in capital flows to emerging market economies, Mr Catão said: “The main driver, by far the most important one, is the growth prospects in emerging markets, which are slowing down relative to advanced countries.” And as the IMF report noted: “The narrowed growth differentials… may not be reversed any time soon.” Another factor that played a role in the slowdown was the first steps towards a tightening of monetary policy in the US.
On a more positive note, the IMF study showed that emerging market economies have so far weathered the slowdown in capital flows much better than they did in the 1980s and 1990, which were characterised by financial and debt crises. This better resilience has been principally thanks to more effective economic management, notably higher foreign exchange reserves, lower shares of debt denominated in foreign currency, and greater exchange rate flexibility. “In particular, countries that display greater exchange rate flexibility have insulated themselves better from the global capital flow cycle than in previous slowdowns,” noted the IMF report.
In another press conference in Washington, IMF chief economist Maurice Obstfeld struck a very cautious note when he referred to the trend of increasing capital outflows from emerging market economies as one manifestation of "tightening global financial conditions". Looking ahead, he noted that while most emerging market economies have managed to cope with this, "more strains could begin to appear".