• Sun. Jul 21st, 2024

Emerging markets hit by record streak of withdrawals by foreign investors


Jul 30, 2022
Emerging markets hit by record streak of withdrawals by foreign investors


Foreign investors have pulled funds out of emerging markets for five straight months in the longest streak of withdrawals on record, highlighting how recession fears and rising interest rates are shaking developing economies.

Cross-border outflows by international investors in EM stocks and domestic bonds reached $10.5bn this month according to provisional data compiled by the Institute of International Finance. That took outflows over the past five months to more than $38bn — the longest period of net outflows since records began in 2005.

The outflows risk exacerbating a mounting financial crisis across developing economies. In the past three months Sri Lanka has defaulted on its sovereign debt and Bangladesh and Pakistan have both approached the IMF for help. A growing number of other issuers across emerging markets are also at risk, investors fear.

Many low and middle-income developing countries are suffering from depreciating currencies and rising borrowing costs, driven by rate rises by the US Federal Reserve and fears of recession in major advanced economies. The US this week recorded its second consecutive quarterly output contraction.

“EM has had a really, really crazy rollercoaster year,” said Karthik Sankaran, senior strategist at Corpay.

Investors have also pulled $30bn so far this year from EM foreign currency bond funds, which invest in bonds issued on capital markets in advanced economies, according to data from JPMorgan.

The foreign currency bonds of at least 20 frontier and emerging markets are trading at yields of more than 10 percentage points above those of comparable US Treasury bonds, according to JPMorgan data collated by the Financial Times. Spreads at such high levels are often seen as an indicator of severe financial stress and default risk.

It marks a sharp reversal of sentiment from late 2021 and early 2022 when many investors expected emerging economies to recover strongly from the pandemic. As late as April this year, currencies and other assets in commodity exporting EMs such as Brazil and Colombia performed well on the back of rising prices for oil and other raw materials following Russia’s invasion of Ukraine.

But fears of global recession and inflation, aggressive rises in US interest rates and a slowdown in Chinese economic growth have left many investors retrenching from EM assets.

Jonathan Fortun Vargas, economist at the IIF, said that cross-border withdrawals had been unusually widespread across emerging markets; in previous episodes, outflows from one region have been partially balanced by inflows to another.

“This time, sentiment is generalised on the downside,” he said.

Analysts also warned that, unlike previous episodes, there was little immediate prospect of global conditions turning in EM’s favour.

“The Fed’s position seems to be very different from that in previous cycles,” said Adam Wolfe, EM economist at Absolute Strategy Research. “It is more willing to risk a US recession and to risk destabilising financial markets in order to bring inflation down.”

There is also little sign of an economic recovery in China, the world’s biggest emerging market, he warned. That limits its ability to drive a recovery in other developing countries that rely on it as an export market and a source of finance.

“China’s financial system is under strain from the economic slump of the past year and that has really limited its banks’ ability to keep refinancing all their loans to other emerging markets,” Wolfe said.

Sri Lanka’s default on its foreign debt has left many investors wondering which will be the next sovereign borrower to go into restructuring.

Spreads over US Treasury bonds on foreign bonds issued by Ghana, for example, have more than doubled this year as investors price in a rising risk of default or restructuring. Very high debt service costs are eroding Ghana’s foreign currency reserves, which fell from $9.7bn at the end of 2021 to $7.7bn at the end of June, a rate of $1bn per quarter.

If that continues, “over four quarters, suddenly reserves will be at levels where markets start to really worry,” said Kevin Daly, investment director at Abrdn. The government is almost certain to miss its fiscal targets for this year so the drain on reserves is set to continue, he added.

Borrowing costs for large EMs such as Brazil, Mexico, India and South Africa have also risen this year, but by less. Many large economies acted early to fight inflation and put policies in place that protect them from external shocks.

The only large EM of concern is Turkey, where government measures to support the lira while refusing to raise interest rates — in effect, promising to pay local depositors the currency depreciation cost of sticking with the currency — have a high fiscal cost.

Such measures can only work while Turkey runs a current account surplus, which is rare, said Wolfe. “If it needs external finance, eventually those systems are going to break down.”

However, other large emerging economies face similar pressures, he added: a reliance on debt funding means that eventually governments have to suppress domestic demand to bring debts under control, risking a recession.

Fortun Vargas said there was little escape from the sell-off. “What’s surprising is how strongly sentiment has flipped,” he said. “Commodity exporters were the darlings of investors just a few weeks ago. There are no darlings now.”

Additional reporting by Kate Duguid in London


Image and article originally from www.ft.com. Read the original article here.