Authors: Franziska Ohnsorge, Stephan Knobloch, Yevgeniya Korniyenko

Capital inflows have returned to many emerging markets since mid-2009.

Fuelled by abundant global liquidity and more favourable growth prospects and debt dynamics, they present better risk-return prospects than advanced economies (Chart 1) [1]

Large emerging markets in Latin America and Asia have received strong capital inflows and many of them have reacted by intervening in foreign exchange markets to avoid currency appreciation, whilst several of them have resorted to restrictions on capital inflows.

Capital inflows are also starting to return to the EBRD region, with a lag and a different composition from that seen in other emerging markets.

In the EBRD region, capital inflows are bolstered by foreign direct investment (FDI), whereas in emerging Asia and emerging Latin America they have been led mainly by more volatile non-FDI inflows.

In fact, many countries in the region have continued to experience non-FDI outflows, as also reflected in outflows of BIS reporting banks (Annex Figure 1).

However, two countries (the “magnets” of the EBRD region) have been exceptions both in size and composition: Turkey and Poland. These have both received strong non-FDI capital inflows, including through banks.

These two countries seem to be part if the global emerging market story. 

Chart 1a. Capital inflows (Balance of payments data)

Chart 1a. Capital inflows (Balance of payments data)

Chart 1b. Cross-border BIS-reporting bank lending flows (Exhange rate adjusted changes in cross-border assets of BIS-reporting banks, in per cent of previous quarter stocks)

Chart 1b. Cross border BIS-reporting bank lending flows (Exchange rate adjusted changes in cross border assets of BIS-reporting banks, in per cent of previous quarter stocks)

Source: IMF BoP statistics and official authorities, Bank for International Settlements (BIS).

Note: Latin America includes Brazil, Mexico and Columbia; Emerging Asia includes India, Indonesia and Thailand; EBRD region magnets include Poland and Turkey. In Chart 1b, the definition of regions from the BIS, for example emerging Europe, excludes Caucasus, Central Asia, Mongolia.

Net FDI inflows proved resilient during the crisis: they declined but did not reverse on a sustained basis.

In the majority of EBRD countries FDI inflows remained positive in 2009 and in 2010 to date.[2] Net FDI outflows on a substantial scale were confined to six countries (Bosnia and Herzegovina, Hungary, Latvia, Lithuania, Russia, and Slovenia) and in most of these from the financial sector as the sector deleveraged.[3]

While net FDI inflows typically remained positive, they shrank sharply and have not recovered to pre-crisis levels—with some exceptions:

  • In Armenia, and Belarus average quarterly FDI inflows never turned negative, as energy-sector related investment, the sale of Beltransgas and investments to “Armrusgasarda”, respectively, proceeded.[4]
  • In Kazakhstan and Mongolia post-crisis FDI inflows have begun to exceed average quarterly flows before the crisis due to investments in the commodity sector.[5]
  • In Albania, FDI remains the main source of current account financing due to continued privatization in telecommunications and FDI in the hydro-fuel sectors.

Non-FDI inflows have been more volatile than FDI in the region.

Non-FDI capital inflows have two main components: direct cross-border lending to banks and corporates and flows intermediated by local capital markets. Direct cross-border lending to banks and corporates has been the main source of non-FDI capital inflows for most countries in the region (except Slovenia and Poland) given that local capital markets are generally underdeveloped (Chart 3).

  • Direct cross border inflows, which remained positive even during the crisis in all but the hardest-hit economies (Ukraine, Baltics, Kazakhstan, but also Azerbaijan and Slovenia), have increased again since the crisis in many countries or outflows have shrunk. Net inflows remain below their pre-crisis levels in all but a few countries (in the Caucasus, the Slovak Republic and Turkey) or even negative (in the Baltics except Latvia, Slovenia, Ukraine, Russia, and Kazakhstan).[6]
  • Following sharp contractions during the crisis, inflows through local capital markets have returned to a few countries in the region, attracted by sovereign debt issuance (Lithuania, Hungary, Poland, Kazakhstan), rebounding equity markets (Poland). The recovery in equity markets in the deeper and more developed financial markets in the region (Poland and Turkey) has been accompanied by a flurry of M&A activity that had dried up during the crisis. In Poland, for example, 443 M&A deals were completed in 2009-2010 to date well above the pre-crisis level of 238 deals in 2008.

Bank for International Settlements (BIS)-reporting banks have continued to reduce their assets in the region by 1.9% in the second quarter of 2010 – and even in advanced Europe –whereas they continued their inflows into other emerging markets (Chart 2).

The continuing deleveraging in the region reflects predominantly developments in Ukraine, Kazakhstan, and Russia. However, even excluding these outliers, BIS-reporting banks deleveraged in all countries but Turkey.  This is partly the reflection of the kind of banks present in emerging Europe and present in Asia: deleveraging in emerging Europe has been similar to that in advanced Europe given the involvement of the same banks.[7]

Chart 2a. Total flows from BIS reporting banks since 2008Q4 (Sum of exacgnge rate adjusted changes in cross-border assets of BIS-reporting banks, in per cent of 2007 Q4 stocks)

Chart 2a. Total flows from BIS reporting banks since 2008 Q4 (Sum of exchange rate adjusted changes in cross-border assets of BIS reporting banks, in per cent of 2007 Q4 stocks)

Chart 2b. Total flows from BIS reporting banks since 2008Q4 (Sum of exchange rate adjusted changes in cross-border assets of BIS-reporting banks, in per cent of 2007 Q4 stocks)

Chart 2b. Total flows from BIS reporting banks since 2008 Q4 (Sum of exchange rate adjusted changes in cross-border assets of BIS reporting banks, in per cent of 2007 Q4 stocks)

 

Annex Figure 1. Net Capital Inflows into EBRD Region

Net capital inflows including FDI

Net capital inflows including FDI

Net FDI inflows excluding FDI

Net FDI inflows excluding FDI

Net FDI inflows

Net FDI inflows

Net portfolio investments inflows

Net portfolio investment inflows

Net other investment inflows

Net other investment inflows

Pre-crisis buildup of external debt

Pre-crisis buildup of external debt

Sources: IMF Balance of Payments statistics, official authorities.

Note: Overall flows including and excluding FDI, net FDI, portfolio and other inflows: Pre-crisis period defined as Q1 2005 – Q2 2008, crisis period as Q3-2008 and Q2 2009, and post-crisis period as Q3 2009 – Q2 2010. The selection of countries is determined by data availability for 2010. Capital inflows defined as a sum of net capital account, net FDI, net portfolio investments, net other investments, and errors and omissions excluding net trade credits and use of IMF resources. For Azerbaijan, Croatia and Poland, net trade credit could not be excluded. For Albania, data for 2010 include net trade credits. For Azerbaijan and Poland, no data on the use of IMF money is available in national BoP statistics. For Albania, Macedonia, Hungary and Slovenia data in 2010 include use of IMF money.

Footnotes:

[1] See IMF World Economic Outlook and Global Financial Stability Report, October 2010.

[2] Stocks of inward FDI reported in the International Investment Position have fallen significantly in 2008-2009 in CEB, Romania and Russia. This was not so much due to FDI outflows, but rather to valuation effects as equity markets corrected sharply. In a few countries the decline in FDI stocks is also related to a decline in intercompany loans.

[3] In Hungary annual FDI inflows stayed positive in 2009, but individual large deals introduced volatility, for example, the restructuring of the General Electric companies registered in Hungary or specific real estate transactions. In Bosnia, capital repatriation occurred mainly in the basic metals sector. 

[4] Other sector which continued to receive FDI inflows in 2009-2010 were the telecoms in Armenia and the financial sector in Belarus.

[5] In October 2009, the government of Mongolia completed a US$ 4 billion investment agreement for the Oyu Tolgoi copper-gold mine with Canada-based miner, Ivanhoe Mines, backed by Anglo-Australian mining giant, Rio Tinto. Kazakhstan has been buoyed by a number of long-term bilateral financing agreements with China, Korea, Russia, and UAE for the oil and gas sector (USD$18 billion long-term investment expected).

[6] The large outflows for Azerbaijan are a reflection of the asset build-up in response to strong current account inflows.

[7] Corporates have generally deleveraged in fewer countries thus far.