Emerging markets are being hit by massive outflows of capital amid growing fears of an imminent credit crunch that could lead to a long term and damaging impact on global capital flows and investment as G20 leaders struggle to contain the impact of the euro debt crisis.
Experts warn that “rapid mood swings” in capital flows have created global financial turbulence that is affecting not only bank loans and portfolio investment flows but also longer-term direct investment in business, which is the backbone of economic growth in many emerging economies.
Andrew Burns, head of macroeconomics at the World Bank, told Emerging Markets that gross capital flows into developing economies had fallen “very sharply” last month.
He said flows dropped by 44% between April and May, the steepest monthly drop since September 2010. “That’s a spectacularly large decline,” he said. “That will have real side effects. It will hit investment and hit confidence.”
The Institute of International Finance (IIF), which represents the world’s largest banks, said net private capital flows to emerging market economies remained “quite volatile and subject to disturbance from the euro area”.
Flows fell in 2011 to $1.03 trillion from $1.09 trillion in 2010 and are expected to fall again this year to $912 billion before rising to $994 billion in 2013.
Over the past six months the process of deleveraging in high income Europe has been having knock-on effects into the developing world particularly in terms of flows into eastern Europe and central Asia, according to Burns. “We are getting headwinds from this deleveraging process in Europe,” he said.
Burns warned developing countries were entering a period of slower growth. “They will not be able to provide that extra above-normal growth that would be a further aid to the global economy,” he said, adding that developing economies would grow 5.3% compared with 6.3% and 7.1% in 2011 and 2012 respectively.
European investors and lenders were for many years among the most important suppliers of capital to emerging Asia and other developing regions of the world. But capital flows from the euro area have become “very subdued in net terms and quite volatile”, according to the IIF.
Around half of the private capital flows into emerging economies are accounted for by foreign direct investment, which has traditionally been more stable than equity investment or bank loans.
But even the outlook for FDI is becoming more clouded because of global turbulence. FDI in emerging markets reached $524 billion in 2011, according to the IIF.
Inflows to emerging markets are projected to fall slightly this year to $499 billion and further to $481 billion in 2013, led by an expected sharp decline in FDI flows to China.
The IIF expects net commercial bank loans to emerging economies to slump this year to $73 billion or half the $143 billion in 2011 before recovering to $123 billion next year as non-European banks take up some of the slack. Lending by non-banks financial institutions is also set to drop this year.
But”looking ahead, overall FDI inflows to emerging markets are projected to fall slightly this year to US$499 billion and further to US$481 billion in 2013, led by an expected sharp decline in FDI flows to China”. Net commercial bank loans to emerging economies are meanwhile projected by the IIF to slump this year to $73 billion or half the $143 billion in 2011 before recovering to $123 billion next year as non-European banks take up some of the slack. Lending by non-banks financial institutions is also set to drop this year.