Emily Vogl, Frank Vogl
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Private Capital Flows to Emerging Markets To Continue At Robust Levels, Says New IIF Report
Leading Bankers Caution About Mounting Emerging Market Risks
Zurich, Switzerland, March 30, 2006 — Total net private capital flows to emerging markets are likely to reach $357 billion this year, which is down from the $400 billion record of 2005, but which is the second highest level ever recorded. The decline reflects substantial pre-financing by sovereign bond issuers last year in anticipation of a tightening of global market conditions, said the Institute of International Finance (IIF) in a report issued today.
The IIF, the global association of financial institutions with more than 340 member institutions operating across the world, projected that net direct investment into emerging markets will reach a record $170 billion this year, from $158 billion in 2005. It forecast that net portfolio equity flows is likely to surge above last year's $62 billion record to a new all-time high volume of nearly $71 billion. After exceeding $91 billion last year, net non-bank private sector lending, mostly in the form of bond purchases, is expected to decrease to about $65 billion this year, and a decline in net commercial bank lending is also anticipated to about $52 billion, down from nearly $89 billion in 2005.
Dr. Josef Ackermann, Chairman of the IIF's Board of Directors and Chairman of the Group Executive Committee of Deutsche Bank AG, stated at a press conference in Zurich at the IIF's Spring Membership Meeting that, "Today's favorable global economic environment, in conjunction with the search for yield and high levels of risk tolerance among investors, continues to provide support for sustained momentum in capital flows to emerging markets. Importantly, investors are also responding to the solid actions taken by a considerable number of emerging market governments to curb inflation, reduce external debt levels, expand trade and boost growth. The performance of a number of countries has strengthened investor confidence."
Dr. Ackermann added that, "To be sure, there are downside risks facing emerging markets that persist in a world characterized by large global current account imbalances, oil market uncertainties and multiple political concerns. It is important that the national authorities in both mature and emerging market economies are vigilant in pursuing sound economic policies. At the same time, investors need to recognize the costly consequences of sudden reversals in global conditions that could impact the markets and they need to act accordingly."
Commenting on market trends at the press conference, the IIF's First Vice Chairman, Mr. William Rhodes, Senior Vice Chairman of Citigroup Inc., Chairman, President and CEO, Citibank N.A., said, "We are seeing the emerging market economies continuing to grow overall by more than 6 percent a year, due in large part to the implementation of sound economic policies. Today's IIF report also points out that many emerging countries have significantly reduced the ratio of external debt to GDP, improved fiscal balances, and improved competitiveness."
Mr. Rhodes noted, however, "The scale of net private capital flows to emerging markets is also due to abundant international liquidity and the reach for high yields by investors. We are seeing spreads on sovereign bonds at record low levels relative to U.S. Treasury bonds and I find it a matter of concern that there appears to be insufficient differentiation by investors between emerging market economies. As we have seen in the past, changes in global conditions can have a swift impact on emerging markets and given global economic uncertainties this is a time when investors need to reassess risks and move forward with caution."
IIF Managing Director Charles Dallara noted that, "I want to emphasize the positive performances that we are now seeing in a considerable number of emerging market economies. Our new forecasts for 2006 suggest growth in emerging Asia at over 7 percent for the fifth consecutive year, while emerging Europe is set to grow again this year by about 5 percent. In addition, in Latin America, Brazil and Mexico are projected to register high GDP growth this year, boosting overall regional growth to 4.2 percent, up from 4.0 percent in 2005. And in the Africa/Middle East region, growth is expected to increase to over 5 percent this year."
Mr. Dallara added, "As we look ahead to influences on the outlook for the markets, it should be noted that we have long voiced concern about the growth of global imbalance. We continue to stress the importance of a multilaterally coordinated G-11 approach to these imbalances with the IMF playing a potentially key role in this process."
Mr. Yusuke Horiguchi, First Deputy IIF Managing Director and Chief Economist, noted that the continuing generally favorable outlook for growth in the leading industrial countries is of primary importance in supporting forecasts for further substantial private capital flows to emerging markets this year. However, he added that, "After several years of outsized returns, with the average per annum return over the past decade of around 16 percent, the sustainability of the favorable environment that has supported the emerging market asset class might be at more risk now than in recent years. The sharply higher valuation itself might start acting as a deterrent. Adverse developments associated with a possible spike in energy prices or a sudden unwinding of global imbalances could affect global growth and interest and exchange rates with negative consequences for emerging markets. Moreover, risk aversion could increase as the growth of global liquidity continues to ebb."
Direct & Portfolio Equity Investment
The most significant increases in net direct investment this year are projected for emerging Europe. China is forecast to continue to receive the vast majority of direct investment in the Asia/Pacific region, accounting once again for about $50 billion. In Latin America, only Mexico is expected to see any noticeable increase in net direct investment this year, accounting for about one-third of such flows to the region. In the case of Brazil, while gross inflows of foreign direct investment are rising visibly, this is being offset by direct investment of Brazilian companies in a number of other countries. The IIF also noted that the record flows of portfolio equity funds this year will come at a time when total equity issuance is likely to exceed the record $50 billion seen last year.
The IIF stated that, despite continued strong bond issuance in the first two months of this year, gross issuance for the full year is likely to fall below the more than $127 billion recorded in 2005, as front-loading by sovereign and corporate borrowers has taken place in anticipation of higher global interest rates. It noted that estimates have been made that suggest that emerging market sovereigns by the end of February had already completed nearly 50 percent of planned issuance for this year. In addition, a number of countries, including Brazil, Colombia, Ecuador, Mexico, Peru, and Turkey, have stated that they will undertake buybacks of external debt in 2006, which will further reduce net non-bank lending.
Commercial Bank Lending
The IIF projected that net commercial bank lending in 2006 will in all likelihood be positive for the fourth consecutive year. Net lending is projected at about $52 billion which, albeit down from nearly $89 billion in 2005, represents a sizable sum in light of the $132 billion cumulative outflow during 1998-2002. The lower anticipated 2006 overall volume is attributable in part to developments in emerging Europe. The IIF forecast that net commercial bank lending to this region may fall to about $35 billion this year from $67 billion in 2005. The decline is most attributable to Russia, where a large repayment of funds used to finance the purchase by Rosneft of a stake in Gazprom and the latter's acquisition of Sibneft is scheduled to take place.
The new report today also noted that net repayments to official institutions continue at a significant level, although the 2006 volume at about $26 billion follows a record level of net repayments of $67 billion in 2005. In terms of the breakdown in flows by creditor group, official bilateral creditors are projected to see net repayments of $13.4 billion in 2006, down sharply from nearly $27 billion last year, when countries like Poland and Russia made prepayments of a significant portion of their Paris Club debt. For the second consecutive year, Russia will make the largest amount of net repayments to official bilateral creditors amounting to $11.5 billion in 2006. The next largest repayment of $2.6 billion is expected to come from Poland. International financial institutions (IFIs) as a creditor group are likely to receive net repayments this year of $12.5 billion, with Argentina accounting for more than one-half of all net repayments. Turkey is expected to make large net repayments for the second consecutive year totaling more than $4.5 billion. China, India and Egypt are projected to obtain the largest net inflows from IFIs in 2006.
Emily Vogl, Frank Vogl