Emerging markets face fourth year of capital outflows

Emerging markets will suffer a fourth consecutive year of capital outflows in 2017, despite an upturn in the macroeconomic background and a surge in portfolio flows to EM equities and bonds in the early weeks of the year, the Institute of International Finance said on Thursday.

“While we project a slight uptick in capital flows in 2017, policy risks and potential deterioration in the global environment make us cautious,” said Hung Tran, the IIF’s executive managing director.

The IIF, an industry association, expects net capital outflows from EMs of $489bn in 2017, after net outflows of $616bn last year and $735bn in 2015.

The IIF’s forecast is dominated by China, which is expected to see outflows of $560bn. The other 24 emerging economies in the IIF’s sample are expected to attract inflows of about $70bn, close to double the amount of 2016.

Investors have put big bets on EM assets already this year, with an estimated $12.3bn in cross-border flows to EM bonds and equities, according to the IIF.

This marks a significant reversal, after outflows of an estimated $1.2bn in December and $30bn in November left 2016 with cross-border flows to EM securities of just $28bn — the weakest year since 2008 and just 10 per cent of the 2010-14 average, according to the IIF.

The IIF said investor sentiment had turned this year on hopes that a fiscal boost in the US under President Donald Trump would be beneficial to global economic growth.

But it warned that uncertainties remained — particularly the severity of US protectionist measures promised by the Trump administration and the outcome of the French presidential election — that could lead to “almost binary” outcomes for EM assets.

“If harsher trade measures are introduced — especially if aimed at the major economies — the disruption to the global economy could be severe,” it said in a note. “A more protectionist stance [would] also have a significant impact on global financial flows.”

IIF said Mr Trump’s promise to keep US investment at home threatened to hit foreign direct investment in emerging markets. It noted that FDI to EMs fell to less than $410bn in 2016 from $526bn in 2015, and predicted a further fall to a post-crisis low of $385bn this year. The IIF has sharply revised down its predictions of FDI to most EMs since its previous predictions in November, with Mexico and South Africa particularly badly affected.

Macroeconomic fundamentals in individual EMs would come to the fore with the withdrawal of liquidity from loose monetary policies by the US Federal Reserve and other developed country central banks.

But EMs would still be subject to external factors, particularly the strength or otherwise of the US dollar, the IIF said.

“Here the stance of President Trump and his advisers will set direction,” it noted. “While the prospect of stronger US growth gave a big boost to the greenback just after the election [in November], a growing belief that Team Trump would much prefer a weaker dollar has meant USD losses year to date — and a bit of respite for many EM currencies.”

The IIF predicted limited upside for the US dollar in 2017, with growing risk of a downside correction if the Trump administration continued to talk down the dollar in support of US exports. “This should offer a benign near-term backdrop for EM portfolio flows — as signalled by the January pick-up,” it said.

However, it warned that projected earnings for EM companies may be overly optimistic and would be at risk for any deterioration in global trade, although “the impact would vary considerably across countries”.