Emerging markets as a whole face the prospect of a potential capital drought as global investors become more selective in an environment of slowing US growth and rising interest rates, Institute of International Finance managing director Charles Dallara told Emerging Markets yesterday. One way in which Asia can maintain portfolio capital inflows in this situation is to further develop its bond markets, he suggested.
The surge in global flows of foreign capital to over $300 billion last year is likely to mark a peak for the time being, said Dallara. Emerging market spreads are widening in Asia and Latin America as "more risk-averse attitudes develop among investors." Access to capital markets will become "more selective" and it is critical for governments to undertake reforms to ensure continued access to external capital.
Financial markets in general face a "crucially uncertain time," Dallara said. "Data from the US indicates that we have shifted from the strong growth of 2003/04" into a period of slower growth. US interest rates "will continue to rise and this poses an issue for the Fed." Long-term US interest rates are "becoming more volatile" while global financial imbalances are putting pressure on US activity. Stagflation could become a threat in this situation with slowing growth and rising rates fed by oil prices and other factors, he said.
Dallara listed financial sector reforms, including bond market development, as among reforms needed in Asia and elsewhere. He described as "laudable" the Asean+3 bond market initiative and other moves to develop regional bond markets in Asia. But, he added, "there needs to be a concerted effort among authorities of the region to subjugate their own individual goals for market development to a more comprehensive plan for the region as a whole."
Asia needs to "develop the culture of bond issuance," he said, and for this to happen "you need a more concerted effort in which issuance is encouraged more actively among sovereign and other borrowers." The bulk of capital flows to emerging markets at present takes the form of foreign direct investment, bank loans and equity investment while bond market investment ranks lower down the scale.
Pradumna Rana, senior director in the newly established ADB Office of Regional Economic Integration sprang to the defence of Asian bond market initiatives, however. The first step has to be "development of national bond markets" before a regional market can be expected to develop in Asia, Rana argued. Only when individual Asian nations harmonize their form of bond issuance can a regional market develop, he said.