Capital Flows Into Emerging Markets to Remain Volatile
World Economy

Capital Flows Into Emerging Markets to Remain Volatile

After an unsteady year in 2014, capital flows to emerging markets (EMs) are likely to remain volatile in 2015. Significant adjustments to global financial conditions in 2014 included a large drop in commodity prices, the end of quantitative easing (QE) in the US and a stronger US dollar.
Looking ahead, these developments, particularly the drop in crude oil prices, will lead to significant divergence in EM performance, adding to risks in specific countries such as Nigeria, Russia and Venezuela, BI-ME reported.
Therefore, we project EM flows to remain volatile in 2015, particularly as a possible increase in US policy rates by the Federal Reserve (Fed) may attract flows to the US while EM growth continues to slow and commodity prices remain low.
Towards the end of 2013 and in early 2014, capital flows to EMs subsided as the implementation of QE tapering in the US led to tighter global liquidity. In mid-2014, EM capital inflows recovered, though they slowed down again in the second half of the year ($86b compared with $131b in the first half of the year, according to the Institute of International Finance [IIF]).

  Capital Flight
The end of QE in the US led to another bout of EM capital flight, weakening exchange rates and prompting some countries to increase interest rates. In turn, this weakened the growth outlook for EMs and led to greater global risk aversion. Finally, a number of EMs have high levels of the dollar denominated debt, which is becoming more burdensome with the stronger US dollar.
Throughout 2014, there was significant EM differentiation between those markets that have been able to take the necessary measures to reduce their current account deficits and stabilize their currencies (notably India and Indonesia) and those that are still struggling to contain the loss of confidence in their economies (Brazil, Nigeria, Russia, South Africa, Turkey and Ukraine).
Much of the loss of confidence in the latter group has been driven by lower global commodity prices, primarily crude oil.
In December 2014 there was a net outflow of both debt and equity capital from EMs of $11.1b (the largest outflow since the announcement of QE tapering in May 2013).
Global risk aversion rose amidst an intensification of the Russian crisis, the further slide in oil prices, which raised concern about a global Great Deflation, and the re-emergence of the risk of Greek sovereign debt default.
Looking ahead, EM differentiation is expected to be a key theme in 2015. A critical issue will be how vulnerable EMs that heavily depend on capital inflows and have high external debt levels will be affected by the continued rise in the US dollar as well as the expected increase in short-term interest rates in the US.

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