Capital outflows from EMs at record levels in 1Q20, but starting to slow

By bne IntelliNews April 9, 2020

Capital outflows from the world’s emerging markets were at an all-time high of $83bn, according to the Institute of International Finance (IIF), but they have started to slow as lockdowns around the world take effect and everyone settles in to wait out the first wave of the spread of the coronavirus (COVID-19) pandemic.

“Since the beginning of the year, EM have experienced record portfolio outflows, larger than during any recent crisis episode," Elina Ribakova, deputy chief economist for the IIF, said in the institute's daily capital flow tracker on April 8. “A combination of the global COVID-19 shock and a substantial drop in oil prices led to outflows of around $83bn in March alone. Year-to-date, our high-frequency tracker shows portfolio equity outflows of $72bn and debt outflows of $25bn. EM Asia was particularly affected, then other EMs began to suffer significant outflows as the pandemic spread. While the COVID19 shock has led to record outflows for the overall EM complex, China assets suffered less with respect to similar outflow episodes.”

As the chart shows, the pace of the outflows have slowed in the last two weeks as the world’s economy changes to a low gear and government’s finally react to the threat of the virus. Economies have been brought to a standstill and everyone has gone into "wait and see" mode.

“It’s all happened very fast. It's now too late to sell, but too early to buy,” said Julian Rimmer of Investec, a veteran trader of emerging markets, in a note to clients last week.

The impact of the pandemic will be enormous, but it is also still early for much of the damage to show up in the official statistics, leaving traders and businessmen in the dark as to the actual severity of the crisis. Economic and financial forecasts seem to be changing on a daily basis. For example, the Association of European Businesses (AEB) just brought out its Russian car sale numbers for March, a leading indicator for the health of the automotive market and a proxy for consumer confidence for the country. The report showed a mild recovery in sales, which were up 4% year on year, continuing a mild recovery for the sector that started last year. The April results are bound to show a complete collapse in sales.

Things are moving so fast that VTB Capital (VTBC) has introduced a number of real-time measures of economic activity that source data from things like Google maps to get some insight on what is happening on the ground today. bne IntelliNews has also been posting results from the Watcom shopping monitor daily that tracks foot traffic in the leading Moscow malls in real time. The index was down 75% y/y as of April 4, as the total lockdown of Moscow is being strictly enforced by the police in the Russian capital.

 

The stop-shock of the coronavirus pandemic makes this crisis worse than that of 2008; however, as this is a public health crisis due to a virus that is expected to burn out after a few months, analysts are expecting a bounce-back of some sort starting in the summer months. The 2008 crisis was a financial crisis that was a lot more destructive, as it left a wave of defaults and massive debts and so the recovery took longer. That’s the theory anyway.

“While we expect a recovery of flows in the second half of 2020, we do not believe that the pickup will be strong enough to bring about a return to 2019 levels,” says Ribakova. “The recovery in flows will most likely follow that of economic activity, with EM Asia leading the way, and Latin America and frontier markets remaining subdued the longest.”

In a podcast this week with bne IntelliNews, Ribakova said that the effect on the leading EM markets and the pace of their recovery will depend heavily on how healthy each country’s economy was going into the crisis. In the case of Russia, its efforts to protect itself from a repeat of the 2014 crisis, when oil prices last collapsed, means it has built up very large reserves and paid down the majority of its debt, so it is well placed to bounce back. However, a country like Ukraine with very thin reserves, albeit a modest debt/GDP ratio, will have a much tougher time recovering.

“For many EMs, weaker inflows mean that they will not be able to continue to run large current account deficits, and rapid adjustments are imminent. In this context, we expect many countries to turn to multilateral support in [the] coming months due to a lack of policy space to support their economies,” said Ribakova.

IIF projects the total non-resident flows to EM to slow considerably in 2020, driven by the COVID-19 shock to global growth and risk sentiment, as well as the fall in commodity prices. Non-resident flows will reach $444bn, half last year’s level of $937bn.

“Thus, 2020 will see weaker flows than either the 2008/09 crisis or the China shock in 2015,” says Ribakova. “Total foreign investments in EMs, excluding China, are expected to come in at $304bn, the lowest since 2004,” said Ribakova. “In terms of the composition, we expect foreign direct investment [FDI] in EM (ex-China) to hold up better, but still fall relative to 2019 levels to $294bn due to excess capacity, while portfolio investment for the year will likely be negative at -$41bn due to the risk-averse sentiment in the first half of this year.”

While the majority of economists are expecting a recovery to kick in during the second half of this year, the pace of that recovery will depend heavily on the extent and the efficacy of the support packages being put together by players such as the International Monetary Fund (IMF), the World Bank, the US Federal Reserve bank and the EU.

The IMF has already set up a $50bn Rapid Financing Instrument (RFI) to help low-income countries – cash that can be distributed fast with no strings attached. The World Bank similarly has a $10bn fund. The Fed has started granting dollar swap lines so countries that hold US treasuries can turn them into cash dollars. And the EU is currently debating setting up a new pan-European debt mechanism so the EU members can issue a joint debt instrument to raise hundreds of billions of euros to finance an economic rescue package. The talks started this week but they are not going well, as member states are divided over the idea, and countries like Germany would prefer to use the country-based mechanisms that are already in place and were used to alleviate the pain in 2008.

And more help is on the way. The IMF has called a press conference for today and is due to announce the introduction of another instrument in the next few days. The IMF is in danger of getting overloaded after it reported that 85 countries, including nine from emerging Europe, had already applied for help. The IMF can deal with all the smaller countries with GDP of $100bn or less, but if one big country like Turkey or South Africa comes knocking at its door it will not have enough resources to cope.

There is already a global shortage of dollars, which both the Fed and the IMF are trying to address. But as the crisis moves out from the political decisions to lock a country down phase and into the financial support phase, things remain very much up in the air.

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