Fears that private capital flows from developed countries to emerging market will be hit by the financial crisis were confirmed yesterday, when the Institute of International Finance (IIF) forecast that this year’s will be two-thirds of last year’s.
The IIF said that overall flows to emerging markets will plunge to $619 billion this year, from just short of $900 billion in 2007. The IIF forecast that flows will decline to $562 billion next year, but acknowledged that the fall could be greater.
Lending by advanced country banks to emerging markets is subject to particular uncertainty given the serious shock administered to banking systems in the US and Europe by the financial crisis, said IIF managing director Charles Dallara.
The only reason why capital flows are not projected to fall even more precipitously is that direct investment in emerging economies by businesses is expected to remain firm, he added.
Emerging economies have already begun to turn to the IMF for emergency balance-of-payments financing, as flows to the less credit-worthy ones begins to dry up. The IMF has activated emergency procedures to get funds flowing quickly to those economies most in need of assistance.
But Bill Rhodes, Citigroup senior vice chairman and IIF first vice chairman, suggested yesterday this is not enough. He called on the IMF to establish a special “contingency fund” to help emerging economies likely to face difficulty in obtaining private capital in the current climate even though they have pursued “prudent economic policies”.
Rhodes also urged the IMF to encourage currency swaps with emerging markets, to give them access to hard currencies which markets may be unable or unwilling to supply.
“It is not surprising given the credit conditions that we have been witnessing and the slowing of global economic activity that there is also a visible slowing of net private capital flows to emerging markets,” he said. Flows held up quite well earlier this year but have dropped sharply in recent weeks, Rhodes noted.
“Emerging markets have suffered more severely in recent weeks that at any time since the onset of the of global credit problems”, the IIF said in a report. “The main channel of this weakness has been a slump in net interbank lending, which is no surprise in view of stresses across global interbank markets.
“While recent and prospective G7 policy actions will eventually restore interbank confidence, we expect net bank lending to remain durably lower as bank capital constraints dampen both willingness and ability to lend,” the IIF said.
Despite current problems, prospective returns in emerging market continue to appear more attractive than those available in mature markets”, the IIF report suggested. “Nominal interest rate spreads remain significant, and stronger growth should support superior profit growth,” it added.