Thursday, July 23, 2015 01:34 PM / ARM Research
Today’s portion of the cut-out from our core strategy document – the Nigeria Strategy Report assesses the movement in FPI flows to emerging markets over H1 2015, and posits our outlook on the same for the remainder of the year
Review of Global Economy and Markets
Accommodative monetary policies and reduced risk appetite drive volatile FPI flows
Following a dovish message from the US Fed regarding normalising interest rates and commencement of ECB’s bond buying program which exceeded market expectations, FPI flows to EM rebounded strongly in Q1 15 to $52.9 billion (+70% YoY and nearly doubled QoQ), according to the IIF reports. However, diminished risk appetite of investors on prospects of an interest rate hike in the US as well as growing concerns of a possible Greek exit from the euro-zone drove a retrenchment in portfolio flows over Q2 15 (-63% YoY and -30.5% QoQ to $36.7 billion). Largely reflecting capital outflows in Q2 15, IIF estimates a 32% YoY contraction in H1 15 net FPI flows to EM.
The delay in normalization of interest rate by the Fed stemmed from weaker macro-economic data, including: GDP deceleration (-0.2% QoQ in Q1 15); dip in consumer confidence; weaker consumer spending; slowing growth of trading partners and non-impressive inflation figures. Focusing on the latter, despite a 0.4% MoM rise in May’s inflation figures (biggest increase in more than two years), inflation figure over 2015 is flat YoY, dragged by lower energy prices, and remains elusive of the Fed’s target of 2%. Consequently, at the June FOMC meeting, the Fed chair, Janet Yellen stated interest rate hike would be underpinned by further improvement in inflation, wage increases, and ability of part-time workers to find full-time jobs.
While monetary tightening in US was postponed, the euro-area expanded its monetary easing by launching its bond buying program which is in addition to the purchase of asset-backed securities and covered bonds that began last year. According to the ECB, the decision to purchase government bonds and other assets worth €60 billion every month until September 2016, or as determined by the bank’s Governing Council, was necessary to stem deflationary pressures as well as boost its slowing economy. Similarly, BoE which also looked to tighten left key policy rate unchanged at 0.5% (lowest on record) on deflationary pressures. Elsewhere, the BoJ maintained its purchase of assets worth 80 trillion yen ($670 billion) to boost inflation which slid to its lowest in 2 years in May, notwithstanding the second consecutive GDP expansion since the country experienced recession last year. Meanwhile amidst slowing growth, Chinese monetary authority (PBoC) cut interest rates for the fourth time since November 2014 to its lowest on record at 4.85% while one-year deposit rate was reduced by 25bps to 2%.
Divergent macroeconomic picture underpins varying flows to EMs
Aside from the discordant monetary policies across the developed world, heightening concerns about Greece debt crises as well as divergent growth picture across EM contributed to the volatile FPI flows over H1 15. Decomposing FPI patterns on a geographical basis reveals strong FPI flows to Asia driven by sustained flows to India, Indonesia and China. In particular, shrugging off concerns about the country’s slowing growth, capital flows to China remained strong as liberalization of the country’s financial market which began with the launching of the Hong Kong-Shanghai Stock Connect last year and inclusion of equity funds in the cross boundary investment channel continue to attract investments. Furthermore, policy stimulus to prop up growth has also sustained investors’ confidence of the market. As for India and Indonesia which both elected pro-reformist government last year, the euphoria as well as visible reforms has continued to boost capital inflows to both countries. Economic reforms implemented in India such as raising ownership limits for insurance, defense, pensions as well as opening up of railways projects alongside tax reform propelled a net FPI flow of $15.6 billion in the first five months of 2015. Similarly, the decision of Indonesia’s government to cut gasoline subsidies as well as implement tax reforms sustained investors’ interest, spurring a net FPI flow of $7.4 billion in Q1 15 with 95% of this amount flowing into the country’s bond market with the government benefitting the most (87% of bond portfolio flows are government related borrowings).
In contrast, EM Europe continues to witness a retrenchment in capital flows over H1 15, with June marking a fifth consecutive month of net capital outflows. The weakness in net FPI flows was largely driven by outflows from Russia, which rose to $31 billion during Q1 15 from $24 billion a quarter during H2 14, as well as concerns about a possible Greece exit from the euro-zone. Capital outflows from Russia continue to be affected by the crises in Ukraine and resulting impact of western sanctions on the Russian economy which is expected to enter recession in 2015. As for Greece, a lack of progress in the negotiation of a third bailout program with its European lenders raised concerns of Greece ability to meet its debt repayment promise as well as government spending stoking fears of a possible exit from the euro-zone. Meanwhile, amidst a slowing economy leading up to parliamentary election in June, intensified concerns about the Turkish central bank’s ability to resist pressures from the government to ease monetary policy led foreign investors to reduce their exposure to Turkey’s securities with FPI outflows over the first four months of 2015 at $16.4 billion, reflecting selloff of both equity and local government bonds. Overall, the region’s capital outflows were mainly equity based, as euro-bond issuance by Russian companies as well as ECB’s bond buying program ensured relatively stronger bond inflows.
Capital flows to the middle-east and North African region appears to have subsided following the crash in oil prices. However FPI flows to Egypt was sustained on the back of political stability and economic reforms such as cutting fuel subsidies by a third, introduction of new taxes and allowing the Egyptian Pound to depreciate. Meanwhile the opening of Saudi Arabia’s $590 billion stock market to foreign investors has continued to attract foreign portfolio flows to the country while capital flows to Tunisia was largely underpinned by the country’s issuance of a $1 billion Eurobond which was more than four times oversubscribed.
Latin America continued to witness strong portfolio flows (both equity and fixed income) on receding market fears of further depreciation of local currencies with Brazil, Mexico and Chile benefitting the most. FPI flows to Brazil’s bond market surged over 2015 as the central bank progressively raised interest rate (+200bps to 13.75% YTD) to its highest level since December 2008 even as fiscal policy, underpinned by cut in government spending and higher taxes, embarked on a consolidation path. In addition, the release of the 2014 audited financial statements of scandal-hit Petrobras’ boosted investments to the country’s stock market; the delay of the report had contributed to increasing uncertainty about Brazil’s economic growth prospects. Altogether, net FPI flows to the country over Q1 15 amounted to $3.1 billion. Similarly, increased reform-related opportunities in key sectors of the Mexican economy attracted capital inflows worth $9 billion to the country with a huge chunk flowing to its equity market. As for Chile, reiteration by its central bank’s president of a possible hike in interest rate towards the end of the year, after over-estimating the output gap in the economy, has boosted bond related inflows into the country as banks and other corporations pre-financed themselves in anticipation of higher borrowing costs.
Capital flows to Africa reflect economic challenges
As with the broader EM grouping, FPI flows to Africa showed diverse trends as the continent faced a confluence of shocks ranging from bearish commodity prices, Ebola epidemic, heightened political environment, increased insecurity concerns and electricity supply constraints. In South Africa, net portfolio flows surged, more-than-tripling to 39.3 billion Rand in Q1 15 with both the equity and debt markets benefitting. The South African debt market benefitted from Eskom’s international bond issuance worth US$1.25 billion while FPI flows to the JSE benefited from primary listings of majorly industrial-sector companies which contributed 93% of the R92 billion equity capital raised in the five months to May 2015. In contrast, capital flows to Nigeria slumped 35.2% YoY to $1.9 billion in the first three months of 2015 reflecting cutback in equities (-49.6% YoY to $1.1 billion). The retrenchment reflects investors’ discomfort with falling oil prices, heightened political risks in the run-up to the 2015 general election as well as policy uncertainty post the election.
Figure 2: FPI flows into Nigerian financial markets ($’million)
For the rest of the African region, FPI flows which have largely been in the form of international bond issuance appears to have subsided partly due to deterioration in economic growth and fiscal deficits as well as advance of the dollar against African currencies. Nonetheless, 4x oversubscription of Cote D’Ivoire’s $1 billion euro-bond issuance indicates that apathy to the African market is not general as countries with strong economic growth such as Cote d’Ivoire (2014 GDP: 7.5%, Q1 15 GDP: 7.7%) would attract investors’ interest.
FPI flows to remain slavish to Fed Interest rate tune and Greece concerns
Prospects for EM portfolio flows hinge crucially on the trajectory of an interest rate hike in the US as improved economic data such as accelerating wage gains, rising incomes, and growing household spending set the stage for an interest rate hike in September 2015. We continue to expect normalisation of monetary policy in the US should shrink the potential quantum of FPI flows into EM regardless of the sustained asset purchases by the BoJ and ECB’s bond-buying. In addition to a US interest rate hike, possible Greece default of its ECB loan would raise global risk aversion to EM countries especially those within Europe, further compounding portfolio outflows from the region. The reduced risk tolerance should also impact portfolio flows to countries with high current account deficit as investors will more likely favour higher quality investment. Nonetheless, nations with strong economic outlook, favourable external positions and credible reform programs should attract strong inflows.
Capital flows to EM Asia is at particular risk of a sharper-than-expected slowdown in Chinese growth, while capital flows to Malaysia and Indonesia will likely be impacted by an interest rate hike in the US as both countries have large foreign holdings of domestic bonds. Meanwhile, India’s economic policies should continue to attract FPI flows to the country. As for the European region, the debt negotiations in Greece and Ukraine-Russia crisis should continue to determine direction of capital flows. Nonetheless, dissipation of political uncertainty that trailed June parliamentary election in Turkey should lead to increased inflow to the country. Elsewhere, Saudi-Arabia’s opening of its equity market to foreigners should continue to underpin FPI flows to the middle–east region. In contrast, FPI inflows to Sub-Saharan Africa will likely remain subdued following slowing economic growth, political uncertainty, rising current account deficit and depreciating currencies. However, plans by Ghana, Tanzania and Kenya to each raise $1 billion Eurobond could deliver some support. In summary, FPI flows will remain wary of EM countries with domestic vulnerabilities such as credit growth and debt burdens, implying portfolio flows will remain volatile over the rest of 2015.
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