DOHA: After two months of outflows, net non-resident portfolio flows to emerging markets (EMs) turned positive in July. The EMs saw inflows of an estimated $11.9bn in July, with equities ($7.9bn) receiving about double the inflows of debt markets, found Institute of International Finance’s (IIF) latest Capital Flows Tracker.
July was still one of the weakest months seen over the past two years. By region, Latin America attracted the most combined equity and debt inflows ($7.2 bn), helped by robust flows to Brazil and Mexico as both countries saw more favourable political developments. EM Asia followed with $5.4bn in combined inflows, while Africa/Middle East was nearly flat ($0.4bn) and EM Europe saw modest outflows (-$1.0 bn) as sanctions reports weighed on Turkish assets.
As part of IIF’s revised tracking methodology, it now includes more comprehensive monthly portfolio equity and debt flows to China in its EM model. China has become increasingly important in overall EM flows picture as its share of total flows to emerging markets continues to rise—from about 25 percent in 2010-2016 to 40 percent in the past two years. This reflects, in part, China’s gradual efforts to open its domestic bond and stock markets to foreign investors.
Equity flows have also received a structural boost over the past year as investors anticipated the two-step MSCI-inclusion process in June and September. Monthly equity flows to China, based on daily data from the China-Hong Kong stock connect, are available for the latest month, while debt flows are available with a one-month lag. IIF estimates equity flows to China were $5.3bn in July, bringing year-to-date flows to $41.4bn vs. $16bn in the same period in 2017. Likewise, $7.6bn flowed into debt markets in June, bringing year-to-date flows to $60bn vs. $9bn last year. However, further RMB weakness could prove to be a significant headwind for such portfolio flows (as it has in the past).
After five months of straight positive net inflows, emerging markets saw net capital outflows of nearly $24bn in June. Against the backdrop of heightened global risk aversion and escalating trade tensions, June’s reversal brought EM capital flows to around $11bn in Q2 2018. This marks a striking slowdown from some $118bn of net inflows in Q1. The retrenchment was most notable in China.
“We estimate that net capital outflows from China were $14.2bn in June—the first monthly net outflows this year. This downturn owed much to the sharp decline in the RMB during the month, which raised concerns that further RMB declines against the USD would prompt renewed capital flight—with significant implications for global markets reminiscent of risk-off episodes in H1 2015 and early 2016”, IIF said.
While RMB weakness provides some breathing room for Chinese exporters as trade tensions persist, Chinese authorities’ efforts to stimulate the economy via expansionary policies should help curb potential capital outflows.
However, stimulus on a big scale could once again trigger a sharp buildup in China’s total debt levels—now close to 300 percent of GDP as of Q2 2018, up from less than 175 percent a decade ago.
Outside China, net capital flows remain lackluster. In June, EMs (ex-China) saw net outflows of some $9.3bn, with outflows in Q2 2018 amounting to some $2bn—the first quarterly outflows since Q4 2015. Almost all the countries in the sample witnessed a marked slowdown in the pace of net inflows in Q2. The slowdown has been most pronounced in India, Poland, Brazil, Argentina and Turkey. IIF’s estimates show that EMs accumulated some $32bn of FX reserves in Q2—vs. $86bn in Q1. However, the bulk of this accumulation was driven by China. In other EMs, central banks sold over $8bn via reserve operations in defense of their currencies.
