Riding the Roller Coaster: Managing Capital Flows to Emerging Markets Charles Collyns Managing Director and Chief Economist Institute of International Finance George Washington University October 213
Twenty Years of Thrills and Spills Total Inward Flows, IIF EM 3 percent of World GDP 3.5 3. 2.5 2. 1.5 1..5 Total, % of World GDP Total, $ Billion (rhs) Tequila Crisis Asia Crisis Argentina Crisis Global Fin. Crisis QE 2 Taper Tantrum $ billion 14 12 1 8 6 4 2. 199 1994 1998 22 26 21 Sources: IIF, IMF Balance of Payments Statistics 2
Roadmap Retrospective: Twenty Years of Flows to EMs Summer of 213 Where next? Four Defensive Strategies Classic Chinese Textbook Brazilian New Orthodoxy 3
Retrospective: What? Emerging Market Private Capital Inflows, Net $ billion 14 12 Direct Equity Investment Nonbanks Portfolio Equity Commercial Banks 1 8 6 4 2-2 1995 1997 1999 21 23 25 27 29 211 213e Source: IIF 4
Retrospective: Where To? Emerging Market Private Capital Inflows, Net $ billion 14 12 1 China EM Asia ex. China MENA Latin America EM Europe 8 6 4 2-2 9 91 92 93 94 95 96 97 98 99 1 2 3 4 5 6 7 8 9 1 11 12 13 Source: IIF 5
Retrospective: Inflows vs. Outflows EM Capital Flows by Residency of Investors $ billion 15 "Private" Resident Outflows Official Reserve Accumulation 1 Non-Resident Inflows Net Flows 5-5 -1-15 -2 1995 1997 1999 21 23 25 27 29 211 213f Source: IIF 6
Retrospective: Mature vs Emerging Markets Emerging vs. Mature Economies: Total Capital Inflows percent GDP, net flows from non-residents, mature = 5 major economies 25 Mature Economies 2 15 Emerging Economies 1 5-5 199 1992 1994 1996 1998 2 22 24 26 28 21 212 Sources: IIF, IMF Balance of Payment Statistics, IMF WEO October 213 7
Retrospective: Growth Drivers Real GDP Growth Rate percent y/y 8 6 4 Contributions to Global Growth percentage points 5 4 3 World 2-2 Mature Economies -4 Emerging Economies -6 1992 1995 1998 21 24 27 21 213 Source: IIF 2 1-1 Mature Economies -2 Emerging Markets -3 1992 1999 26 213f Source: IIF, f = IIF forecast 8
Retrospective: Growth Drivers EM Share of Global GDP percent of World GDP 5 45 4 35 3 25 2 15 Nominal GDP PPP EM Share of Global Stock Market Capitalization percent 24 2 16 12 8 4 1 1994 1998 22 26 21 Source: IMF WEO October 213 21 23 25 27 29 211 213 Source: Bloomberg 9
Retrospective: Market Drivers Policy Rate Differential and Total NonResident Inflows percentage points $ billion 6 5 4 3 2 Emerging Market Sovereign and Corporate Bond Spreads spreads to U.S. Treasuries, basis points 1, 8 CEMBI (Corporate) 4 EM vs DM* 1 6 4 EMBIG (Sovereign Hard Currency 3 Total Nonresident Inflows, IIF EM 3 (rhs)** 2 25 27 29 211 213 *Daily Data, **Quarterly Data Sources: IIF, Bloomberg -1-2 -3 2 GBI-EM (Local Currency) 25 26 27 28 29 21 211 212 213 Source: Bloomberg 1
Retrospective: Drivers Market Volatility and Total Nonresident Inflows index VIX Index (inverted) Total Nonresident 5 Inflows, IIF EM 3 (rhs) 1 15 2 25 3 35 4 45 5 25 27 29 211 213 Sources: IIF, Bloomberg $ billion 4 3 2 1-1 -2-3 11
Retrospective: Impact of QE Cumulative Equity and Bond Flows into EM Funds Around Fed QE Episodes $ billion; t= are starting dates for QE decision 1 5 QE1 Dec. 28-5 QE2 Nov. 21 Operation Twist Sept. 211-1 Operation Twist Extension June 212 QE3 Sept. 212-15 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 Source: IIF, EPFR 12
Summer of 213 13
Taper Tantrum Returns on Selected Asset Classes percent, returns from 5/22/213 to 9/5/213 14 12 1 8 6 4 2-2 -4-6 -8-1 Crude oil* Commodities* Gold* MM equities** BBB corporate U.S. dollar*** 1yr Germany Govt. Bond EM corporate (FC) EM FX Index 1yr U.S. Treasury EM equities** EM Sovereign (LC) EM sovereign (FC) * GSCI; total returns. ** MSCI; total returns, *** DXY index Sources: global corporate and U.S. Treasuries: Bank of America/Merrill Lynch indices; Bloomberg 14
EM Funds: Swings and Roundabouts Cumulative Equity and Bond Flows into EM Funds $ billion, trend estimated with HP filter; EPFR data 3 25 Equities 2 15 Trend 1 5 Trend Bonds -5 24 26 28 21 212 Sources: IIF, EPFR 15
EM Bond Issues: Looking for Market Opportunities Emerging Market External Bond Issuance* $ billion 4 35 3 25 2 15 1 5 Emerging Asia Africa/Middle East Emerging Europe Latin America Jan 8 Jan 9 Jan 1 Jan 11 Jan 12 Jan 13 Source: Thomson Financial; IIF calculations. * Includes foreign currency denominated bonds issued in an external market, for the 3 major EM countries covered in the IIF Capital Flowsreport. 16
Who Was Worst Affected? Current Account Vulnerability a Key Exchange Rate Driver 6 Current account 3 PL KR as a % of GDP (latest available data) RO HU CN -7-6 -5-4 -3-2 -1 1 2 3 4 5 6-3 CL PE RU PH ZA TH-6 MX MY TR -9 BR Increase in Policy Rate Source: IIF IN ID -12-15 -18 Decrease in Policy Rate No Change in Policy Rate Exchange Rate Since May 23 17
Policy Response Since May 23: Key Policy Key Policy Liquidity FX FX Relax Restrictions Macro-Prudential Rate Hike Rate Cut Measures* Swaps** Intervention Capital Inflows Measures*** Indonesia India Turkey Thailand South Africa Brazil Russia Mexico Romania Hungary South Korea Poland Countries sorted in descending order of FX depreciation since May 23; Color code: red = tightening, green = easing *Interest rate adjustments (other than the key policy rate), liquidity injection, reserve requirement changes **For banks, companies ***For real estate, etc. Source: IIF 18
Where Next? 19
Gradual Recovery Barring Accidents Major Emerging Markets: Capital Inflows $ billion, red lines = annual averages, non-resident flows to BRIC, Turkey, Mexico and Indonesia 3 IIF Forecast 28 26 24 22 2 18 16 14 12 21Q1 21Q3 211Q1 211Q3 212Q1 212Q3 213Q1 213Q3 214Q1 214Q3 Sources: IIF, IMF Balance of Payment Statistics 2
Emerging Markets May Slow, But Will Still Grow Much Faster than Advanced Economies Real GDP Growth percent change over a year ago 8 6 4 2-2 Mature Economies Emerging Economies -4 28 29 21 211 212e 213f 214f Source: IIF 21
EM Financial Globalization to Continue BRIC and G3: Financial Globalization and Financial Deepening (22-212 data) y-axis: total financial assets in % of GDP, x-axis: (foreign assets + foreign liabilities) / GDP 5 45 Financial Depth Japan 4 U.S. 35 3 25 2 India China Euro Area 15 1 Brazil Russia 5 Financial Globalization 5 1 15 2 25 3 35 4 Sources: IIF, Datastream 22
Room for Growth EM Weight in Global Economy and Benchmark Portfolio percent 4 35 3 25 2 15 1 5 EM Share of Global GDP EM Share of MSCI ACWI 27 29 211 213 Sources: IIF, Bloomberg, IMF WEO October 213 Emerging & Mature Market Equities: Relative Value ratio of EM to MM forward P/E ratios; line = long run average 1.5 1..95.9.85.8.75.7.65 EM Equities Cheaper EM Equities More Expensive.6 25 27 29 211 213 Sources: IIF, Bloomberg 23
Room for Growth Foreign Holdings of Domestic Government Securities percent of total government debt securities 7 6 Foreign Holdings of Domestic Government Securities percent of total government debt securities 7 6 France 5 5 Germany 4 Indonesia 4 UK 3 2 Malaysia Turkey 3 2 U.S. 1 Korea Thailand 25 27 29 211 213 Sources: ADB, National Sources 1 Japan 25 26 27 27 28 29 21 211 212 213 Sources: Bruegel, ADB 24
Managing Capital Inflows: Four Defensive Strategies 25
Why does it matter? Capital surges: Defensive Strategies if fixed exchange rate, then credit boom (and bust), inflation; if sterilize, quasifiscal losses if float, overvalued exchange rate Sudden stops: If fixed exchange rate, then liquidity shock, reserve depletion, crisis If floating exchange rate, then inflation, currency mismatches 26
Four approaches Defensive Strategies Classic Chinese: fixed exchange rate, limited capital account opening, intervene as needed Textbook: balanced macro, let ER move Brazilian: heterodox macro plus CFM New Orthodoxy: market based with strong macro fundamentals 27
What: Classical Chinese Defense Largely closed capital account Open to FDI Limited opening for other inflows Fixed exchange rate Intervention/sterilization as needed Who: China (decreasingly), India (199s), Malaysia (1998), Argentina (today), low income countries (decreasingly) 28
Classical Chinese Defense Strengths Maintain competitiveness Reduce external crisis risk Weaknesses Repressed financial system Sterilization can be expensive Potential loss of monetary control 29
What: Textbook Floating exchange rate with inflation target Intervention for smoothing only Conservative fiscal policy, with low public debt and medium-term framework Sequenced opening of capital account IMF backstop Who: IMF policy advice before 28 3
Textbook Strengths Room for countercyclical responses Encourages financial development Weaknesses Swings in competiveness Political obstacles to balanced policies Prone to credit booms and busts IMF stigma 31
What: Brazilian Defense Floating exchange rate with inflation target Intervention for steering as well as smoothing Pragmatic fiscal policy Use macroprudential and tax tools to influence capital flows Who: Chile (199s), Brazil, India, Turkey 32
Brazilian Defense Strengths Responsive to circumstances Leans against exchange rate swings, credit booms Weaknesses Success only temporary Financial distortions, illiquid markets May affect composition not volume of flows 33
CFM as Last Resort Source: IMF 34
Resilience to Capital Inflows Source: IMF WEO October 213 35
Most Resilient/Most Exposed Most Resilient Somewhat Resilient Somewhat Exposed Most Exposed China Czech Republic Slovak Republic Lithuania Philippines El Salvador India Belarus Mexico Chile Estonia Ecuador Guatemala Thailand Hungary Turkey Malaysia Poland Argentina Jordan Peru Russian Federation Indonesia Morocco Uruguay Colombia Latvia Venezuela Sri Lanka Ukraine South Africa Pakistan Slovenia Croatia Romania Dominican Republic Brazil Bulgaria Color Code: Free Float, Float, Managed, Fixed Source: IMF WEO October 213, IMF Annual Report on Exchange Arrangements and Exchange Restrictions 212 36
What: New Orthodoxy Textbook macro policies Commitment to deep and liquid domestic financial markets and open capital account Who: Chile, Malaysia, Mexico, Poland, Czech Republic Smaller advanced economies (Australia, Canada, New Zealand, Norway, Sweden, United Kingdom) 37
New Orthodoxy Strengths Room for counter-cyclical responses Weaknesses Still can be vulnerable to exchange rate swings and credit booms and busts 38
Some Concluding Questions When will emerging markets become more like mature markets? Implications of end of easy money? (What is the new normal?) Role of macroprudential tools? Should the Fed worry more about spillovers to EMs? 39
Thank You See our reports on www.iif.com: Capital Flows to Emerging Market Economies, October 213 Structural Challenges to Emerging Market Growth, October 213 4 4