TRENDS, DYNAMICS, AND CHALLENGES OF CAPITAL FLOWS TO FRONTIER MARKETS

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1 HIGH-LEVEL CONFERENCE ON MANAGING CAPITAL FLOWS: LESSONS FROM EMERGING MARKETS FOR FRONTIER ECONOMIES MARCH 2, 2015, MAURITIUS TRENDS, DYNAMICS, AND CHALLENGES OF CAPITAL FLOWS TO FRONTIER MARKETS By Henry K. Rotich, Cabinet Secretary, The National Treasury, Kenya 1

2 Capital flows to Frontier Markets I will speak on the following (with some reference to EAC and Kenya): Trends and dynamics Characteristics and composition of these flows Challenges Policy measures that can be taken 2

3 TRENDS OF CAPITAL FLOWS TO SSA Overall, positive picture of increasing capital flows to SSA Both ODA, FDI and Portfolio have increased over time ( ) US$ billions NET CAPITAL INFLOWS TO SSA Outflow in 2008 due to GFC. - (20) FDI PORTFOLIO Source: World Bank Database 3

4 Frontier Markets increasingly receiving portfolio flows, but slowed in

5 Capital flows to EAC - FDI Stock of FDI has increased over time -- US$ 10 bn in 2007 to US$ 22.8 bn in 2012, largely due to: FDI STOCK IN EAC REGION , US$ million Burundi Rwanda Kenya Uganda Natural resource exploration (oil, gas) Infrastructure dev t - ports, energy, roads Cross border banking activities in the region Expansion of Telecommunication services in Rwanda and Kenya Source: UNCTAD Database

6 Capital flows to EAC - Portfolio Portfolio flows in EAC is still low: Presence of capital restrictions in Tanzania, Rwanda, Burundi. Kenya and Uganda do not have restrictions In Kenya, net portfolio inflow is gradually rising mainly due Increasing opportunities for investments, increasing returns to investments, and, declining risks attributed to macroeconomic stability KENYA: PORTFOLIO EQUITY NET INFLOW US$ million

7 Capital flows to EAC Banking sector Cross border capital flows increased steadily in the region due to: BRANCHES OF KENYAN BANKS SUBSIDIARY IN THE REGION 125 Growth in Pan African banking groups in SSA Expansion of Kenyan banks in the EAC member States and S. Sudan (282 subsidiaries as at December 2012) Kenyan banks prefer investing in a subsidiary while expanding to the region Burundi South Sudan Rwanda Tanzania Uganda 70

8 Remittance flows to EAC Increased remittance inflows the EAC region Migrant's Remittances, For Kenya, remittance inflows have increased significantly averaging about USD 100m per month since January 2013 US$ million US$ M Burundi Kenya Rwanda Source: UNCTAD Database Monthly Remittance Inflows US$ M Feb-10 Jan-10 Mar-10 May-10 Apr-10 Jun-10 Aug-10 Jul-10 Sep-10 Nov-10 Oct-10 Dec-10 Feb-11 Jan-11 Mar-11 May-11 Apr-11 Jun-11 Aug-11 Jul-11 Sep-11 Nov-11 Oct-11 Dec-11 Feb-12 Jan-12 Mar-12 May-12 Apr-12 Jun-12 Aug-12 Jul-12 Sep-12 Nov-12 Oct-12 Dec-12 Feb-13 Jan-13 Mar-13 May-13 Apr-13 Jun-13 Aug-13 Jul-13 Remittance Inflows (US$ M) 12 month Average (US$ M) 8

9 In Sum, net capital inflows to FM/EAC/Kenya have increased due to: Better economic prospects in FM: Economic reforms (liberalization of the trade, exchange rate and financial sector) Improved macroeconomic management successful IMF programs, positive ratings (CPIA, S&P, Fitch, etc.), improved creditworthiness Low debt levels Investments in infrastructure resulting to stronger growth Natural resource exploration Cross border investments Improved democracy and political stability - risk profiles are changing Growing integration in the world capital market - sovereign bonds, portfolio flows and international lending 9

10 Push factors Weak economic growth in advanced economies Excess liquidity and low bond yields in advanced economies (due to monetary easing) has led to search for better yields Risks: Global liquidity are cyclical and can pose balance of payments challenges E.g monetary unwinding in US has put pressure on exchange rates of EM and FM Investor risk aversion is highly volatile, and can change abruptly in response to political as well as economic events. 10

11 Challenges of Capital Flows to FM Important points to note: Composition of the flows: what proportions are ODA, FDI, bank lending, portfolio? Most flows to FM are largely FDI and ODA good for growth Portfolio flow rising but yet to be significant to pose major risks Links to bank financing that can potentially fuel stock and housing (real) prices are still low Use of the flows: are they used for reserve accumulation or financing current account deficits? Some FM have used it to accumulate reserves, others have financed CADs CADs: are they for consumption or productive investments? 11

12 Kenya: Reserve Accumulation Vs CAD Capital flows partly used to accumulate foreign exchange reserves Also the current account deficit has widened But important to note the dynamics of CADs in FM before making conclusions Kenya s Current Account Deficit & Official Reserve Asset (US$ million) Current Account Balance Official Reserves

13 Current Account Deficits in FM/EAC/Kenya Are large around 7-12 percent of GDP Driven by rising trade deficits and lower transfers ODA and FDI are major sources of financing But more recently, increasing access to external market borrowing sovereign bond issuance Reflects savings-investment gap But public sector fiscal deficits are relatively high 13

14 Current Account Deficits Issues to note FM/EAC/Kenya Large CAD and fiscal deficits largely reflect huge infrastructure investment Consumption spenders need to watch Debt levels remain sustainable, even with recent Eurobond issuance But there is need to be cautious Reserves remain at comfortable levels But with vulnerabilities precautionary facilities are needed Kenya CAD reflects importation for large infrastructure projects such as Geothermal Plants, SGR, oil and gas exploration equipment CAD overstated transfers (remittance, tourism receipts not fully captured) CA deficit reflect fiscal deficit which is financed by concessional ODA FDI data understated 14

15 Some policy measures Sustained prudent macro management Cautious access to external borrowing Monitor capital flows and their composition Improve BOP statistics Coordinate cross border surveillance of financial flows Strengthen regulatory capital for banks Monitor push factors and their potential backlash Design new precautionary/insurance facilities for FM 15

16 CONCLUSIONS Capital flows in the FM/EAC region have largely been FDI and ODA, which are long-term in nature, the possibility of capital reversal may be minimal The growth in FDI flows has been to the productive sectors of the economy (Infrastructure, IT, Extractive industries and Mining in the last decade), hence boosting investment and growth The region has also seen growth in remittance inflows since early 2000 and needs to be properly captured in BOP statistics Data challenges underestimate FDI flows and overestimate portfolio flows. This may lead to wrong policy prescription. Portfolio flows to the region, if correctly measured, is still low but needs to be monitored closely 16

17 Thank you 17

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