Emerging markets finance is at an historic juncture but risks related to investor exuberance are growing, warned Bill Rhodes, first vice chairman of the Institute of International Finance’s Board of Directors and senior vice chairman of Citigroup, at the IIF’s Spring Membership meeting in Zurich.
Rhodes said that it is a “matter of concern that there appears to be insufficient differentiation by investors between emerging market economies”.
“Spreads on sovereign bonds are at record low levels relative to US Treasury bonds and one has to ask whether such spreads genuinely reflect the risks that investors are taking in countries that are not pursuing the medium-term economic policy
strategies to sustain growth and sustainability”.
And, adds Rhodes: “The reason for concern is all the greater because of the broad vulnerabilities in emerging market finance at this time. The global current account imbalances that overshadow the world’s economy are not being addressed. The risks to the markets that could surface as a result of shocks associated with these imbalances, or an unanticipated slowdown in global growth, are significant.”
Rhodes’ comments were made in relation to the news that the IIF is expecting private capital flows to emerging markets to continue at robust levels in 2006. The IIF is now forecasting flows to hit $357 billion in 2006 – down from the record $400 billion achieved in 2005 – but still the second highest level ever recorded. The new forecast is an 11% increase over the figure released by the IIF in January.
Net direct investment and net portfolio equity flows are both predicted to hit record highs, at $170 billion and $71 billion respectively, but net non-bank private sector lending – mostly net new bond investment – is expected to drop from $91 billion in 2005 to $65 billion. The IIF believes that drop to be a consequence of both substantial pre-funding last year in anticipation of rising interest rates and the external debt buybacks expected to take place across much of Latin America this year.
Questioned at the spring meeting, the IIF’s Rhodes pointed out that with interest rates rising across the US, Europe and now Japan – which, as he notes “has provided tremendous amounts of liquidity to the market’ – global liquidity would now start to diminish and that might lead to increased risk aversion and a re-assessment of emerging markets risk.
“We’re talking about a matter of time here”, commented Rhodes. Responding to a further question as to whether the sharp movements in the Icelandic and New Zealand currencies should be a cause for concern in emerging markets, Rhodes responded: “It’s very difficult to say that these are early indications of a problem when they might just be isolated incidents.”
Yusuke Horiguchi, first deputy IIF Managing Director and Chief Economist was less cautious, remarking that, while many emerging market countries had done a good job of getting their current account balances into shape, investors might now want to take a closer look at those countries that had not done so.