Reviews & Outlooks | |
Reviews & Outlooks | |
3543 VIEWS | |
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Saturday, July 15,
2017 02.55PM / ARM Research
In today’s cut-out of our core strategy document – The Nigeria Strategy
Report, we review developments pertaining to the direction of FPI flows across
developed and emerging markets. In addition to delineating the drivers of
portfolio flows over H1 17, this section presents our outlook on drivers of FPI
flows over the rest of the year.
According to the Institute of International Finance (IIF), net portfolio flows sustained its positive trend for the seventh consecutive month in June 2017, with combined flows of $121 billion over H1 17 being five-fold higher YoY. The strong capital flows emerged despite three rate hikes in the US and political worries in Britain, as investors cheered the strong economic picture across Emerging markets. Against the backdrop of improved fundamentals, which lessened default risk, foreign demand for local denominated fixed income instruments also tracked higher.
Across the various regions, EM Asia witnessed improved portfolio inflow
following investors reassessment of India’s growth prospect while portfolio
outflows from China reduced against the backdrop of better than expected
economic growth, monetary tightening and capital control curbs implemented in
2016. Over in Latin America, capital flows continued to exit the Brazilian
economy (January to May 17: -$1.8 billion) against the backdrop of lingering
economic recession , lower interest rate and rising political instability.
Emerging Market Europe witnessed higher portfolio inflows (+80% QoQ to $54
billion) in Q1 17 largely reflecting favourable economic picture across member
countries. Over in the Middle East and North African (MENA) region, Egypt
concluded its largest public bond issuance, a multi tranche bond of $4 billion,
in January and an additional $3 billion in May 2017.
After two years of reticence, foreign investors’ appetite for Sub-Sahara
Africa’s (SSA) assets appear to have improved following the upswing in
commodity prices. The rebound is expected to bolster economic recovery, narrow
the widening trade deficit and by extension stabilise the frail currencies in
the region. Largely reflecting these improved fundamentals, Eurobond issuances
across SSA rebounded strongly (+133% YoY to $3.5 billion) over H1 17 with Cote
D’Ivoire, Nigeria and Senegal’s offer been oversubscribed by 4x, 8x and
8x times respectively.
Going into the second half of the year, the demand for EM equities is
expected to remain strong amidst expectation of improving growth prospects.
However, the outlook for capital flows to EM debt is less sanguine. The
expected slowdown in FPI flows to EM debt instrument is set against the
backdrop of anticipated decline in commodity prices, which should increase the
vulnerabilities of resource-rich countries, as well as an increasingly
divergent outlook on global monetary policy.
On balance, we expect the impact of hawkish monetary policy outlook in the US as well as the UK, aided by the rising spate of political uncertainties across the various regions, to moderate growth induced rise in portfolio flows to EM markets.
Strong pull factors
stimulate FPI flows to EM assets
According
to the Institute of International Finance (IIF), net portfolio flows sustained
its positive trend for the seventh consecutive month in June 2017, with
combined flows of $121 billion over H1 17 being fivefold higher YoY. The strong
capital flows emerged despite three rate hikes in the US and political worries
in Britain (legislative election and Brexit concerns), as investors cheered the
strong economic picture across Emerging markets. Particularly, over Q1 17, EM
growth expanded at its fastest pace in ten quarters at 4% YoY with the upbeat
picture sustaining appetite for equities1. Against the backdrop of improved
fundamentals, which lessened default risk, foreign demand for local denominated
fixed income instruments also tracked higher2.
Importantly, despite rate hikes by the US Fed, portfolio flows to EM debt was boosted by falling yields3 in the US. The declines derived from worries that President Trump will have trouble pushing forward with a pro-growth agenda focused on taxes and infrastructure, which had raised scope for higher government borrowings.
Capital flows track
higher across varying EM regions
Across
the various regions, EM Asia witnessed improved portfolio inflow following
investors reassessment of India’s growth prospect. In contrast to the preceding
quarter where de-monetisation-induced worries weighed on investors’ sentiment,
portfolio flows to India rebounded strongly in Q1 17 with the $11.1 billion
(equities: $6.4 billion, debt: $4.7 billion) net flow being the highest in
eight quarters. Improved foreign demand for Rupee assets reflected investors’
expectation for a faster than expected economic recovery, following the rebound
in Manufacturing and Services PMI in February 2017.
The
electoral victory of ruling Bharatiya Janata Party (BJP) in key state assembly
elections in March, which raised prospects for the implementation of the Goods
& Services tax(GST) as well as other economic reforms, further bolstered
investors’ confidence. Similarly, portfolio flows to Thailand rebounded in Q1
17 to $1.8 billion (from a net outflow of $6.07 billion in the previous
quarter) following improved political climate. The October 2016 death of King
Bhumibol Adulyadej, who was perceived as a pillar of stability in the country’s
tumultuous political environment, had stoked worries over planned general
elections4 initially scheduled for 2017. However, the peaceful transition
to his son,
Maha
Vajiralongkorn, as the head of country’s monarchy allayed investors’ fears
irrespective of the postponement of the general election by another year. The
mix of political stability, upbeat economic picture (Q1 17 GDP: +30bps from
reading to 3.3% YoY) and rising real interest rates5 underpinned the influx of
portfolio flows to equities (Q1 17: $262 million, Q4 16: $3.7 billion outflow)
and debt (Q1 17: $1.6 billion, Q4 16: $2.4 billion outflow). In contrast, the
pace of portfolio outflow from Malaysia accelerated in Q1 17 (+67% QoQ) as
investors continue to react to the Central Bank’s curbs on the Ringgit trading
at the non-deliverable forward market (which is used for hedging by foreign
investors).
Given
perceived illiquidity at the onshore market (alternative to NDFs), foreign
investors, worried about currency risk, began to scale down on their
investments. despite the robust economic picture (Q1 17 GDP of 5.6% YoY is the
strongest in eight quarters), Elsewhere in the region, given sustained rise in
China’s foreign reserves6 (printed at a seven-month high of $3.1 trillion in
May 2017), portfolio outflows from China likely reduced against the backdrop of
better than expected economic growth, monetary tightening and capital control
curbs implemented in 2016.
Over
in Latin America, capital flows continued to exit the Brazilian economy
(January to May 17: -$1.8 billion) against the backdrop of lingering economic
recession7, lower interest rate and rising political instability. In less than
a year after impeaching its former President (Dilma Rouseff), Brazil faced
another period of political uncertainty following corruption allegations levied
against current President Michel Temer by the country’s attorney general.
Elsewhere,
in the region, FPI flows to Mexico extended the positive trend in H2 16,
printing at $8.6 billion, reflecting sustained appetite for both peso
denominated debt and equity instruments. Focusing on the former, improved
economic picture which sawQ1 17 GDP print at a six-quarter peak of 2.8% YoY,
and the partial liberalisation of the oil and gas sector8 underpinned the $2.3
billion net inflow into the country’s equities market.
In
the debt market, a 75bps rate hike by the Bank of Mexico over Q1 17 sustained
influx of portfolio flows. Meanwhile, just over a year after returning to the
international capital market, Argentina issued its first century bond worth
$2.75billion which was nearly four times oversubscribed. It is our view that
investors continue to cheer the pro-market policies (including allowing a free
float on the peso, removing grain export taxes as well as a tight lid on fiscal
deficit) implemented by the country’s President, Mauricio Macri.
Emerging
Market Europe witnessed higher portfolio inflows (+80% QoQ to $54 billion) in
Q1 17 largely reflecting favourable economic picture across member countries.
Specifically, GDP printed at a five-quarter peak in both Czech Republic (Q1 17:
+3% YoY) and Poland (Q1 17: +4% YoY), underpinning an upsurge in FPI flows into
these countries’ assets in the first quarter of the year. In addition to the
upbeat economic picture, higher FPI flows to Czech Republic reflected
investors’ expectation for the floatation of the Koruna9, vs. a currency cap in
place previously.
However,
the optimism into Koruna denominated assets soon turned sour10 following
political wrangling between the Prime Minister and his Finance Minister, which
eventually led to the exit of the former. Elsewhere, following the failed coup
in July 2016 which triggered capital outflows in the second half of 2016, FPI
flows to Turkey rebounded strongly over H1 17 (January to April: $7.4 billion)
as investors reassess impact of the political event which appears to be less
severe than predicted.
Importantly,
Turkey’s President has consolidated his powers11 after the approval of the
government-proposed constitutional referendum even as the economy’s GDP printed
at a three-quarter high of 5% in Q1 17.
Over in the Middle East and North African (MENA) region, Egypt concluded its largest public bond issuance, a multi tranche bond of $4 billion, in January and an additional $3 billion in May 2017. Foreign appetite for Egyptian securities improved in the wake of IMF support program which has resulted in implementation of pro-market policies (including removal of fuel subsidy and floatation of the Egyptian pound). Despite robust economic growth in Tunisia (Q1 17 GDP of 2.1% YoY is the highest in nine quarters), net FPI flow to the country plunged 74% QoQ to 11.2 million Tunisian Dinar as investors fret about the country’s rising trade deficit (+57% YoY to $1.68 billion in Q1 17). Elsewhere in the region, the pace of capital outflows accelerated in Qatar (four-fold QoQ to 5.8 billion Qatari Riyal).
Higher commodity prices
bolster capital flows to Africa
After
two years of reticence, foreign investors’ appetite for Sub-Sahara Africa’s
(SSA) assets appear to have improved following the upswing in commodity prices.
The rebound is expected to bolster economic recovery, narrow the widening trade
deficit and by extension stabilise the frail currencies in the region. Largely
reflecting these improved fundamentals, Eurobond issuances across SSA rebounded
strongly (+133% YoY to $3.5 billion over H1 17) with Cote D’Ivoire, Nigeria and
Senegal’s offer been oversubscribed by 4x, 8x12 and 8x times respectively.
Interestingly,
South Africa reported a net portfolio inflow of 25.9 billion Rand in Q1 17 (Q4
16: 1.9 billion Rand) despite the contractionary trend in the country’s economy
as well as lingering political worries. Though foreign investors continue to
shun South Africa’s equities13 (Q1 17 net FPI outflow: +34% QoQ to R16.1
billion), the net positive capital flow largely stemmed from higher demand for
Rand-denominated debt securities (Q1 17 net portfolio inflow surged threefold
QoQ to R42.1 billion). According to the South African Reserve bank, increased
capital flows to South Africa’s debt market reflected rising real interest rate
following a downtrend in inflation as well as improving trade balance (which
swung from a deficit of R7 billion in Q3 16 to a surplus of R57 billion in
Q1 17).
Similarly,
net portfolio flows to Nigeria picked up from a three-quarter trough of $303
million in Q4 16, rising 45% QoQ to $438 million (Q1 16: $227 million). The
renewed appetite for naira securities largely reflected the combined impact of
higher crude oil proceeds and more importantly improved FX liquidity stemming
from the increment in CBN’s dollar sales. Instructively, amidst elevated
interest rate environment and falling YoY headline inflation, foreign capital
largely flowed to short term debt instrument which contributed nearly half14
(QoQ: +107%, YoY: +212% YoY to $212 million) of the net inflow.
Though
net portfolio flow data for Q2 17 is yet to be released, inflow data released
so far suggest an upsurge in portfolio flows in the wake of CBN’s liberalisation
of the currency market in late April. Aside from boosting liquidity in the FX
market, the creation of a market-determined FX window is expected to boost
earnings of companies listed on the Nigerian stock exchange after difficulties
in assessing FX for critical imports had crimped earnings.
Against this backdrop as well as improvement on the macro front, inflow of capital to the equities market surged to a 17-month high of $267 million which, together with flows to the debt market, raised influx of portfolio flow to a nine-month high of $337 million in May.
Hawkish US policy and geopolitical concerns to weigh on EM risk appetite
Going
into the second half of the year, the demand for EM equities is expected to
remain strong amidst expectation of improving growth prospects. Specifically,
the World Bank and IMF both project that the EM group would record its first
GDP growth in seven years over 2017. However, the outlook for capital flows to
EM debt is less sanguine.
The expected slowdown in FPI flows to EM debt instrument is set against the backdrop of anticipated decline in commodity prices, which should increase the vulnerabilities of resource-rich countries, as well as an increasingly divergent outlook on global monetary policy. Focusing on the latter, after lowering its interest rate to a record low of 0.25%, the BoE is now considering raising interest rates as it aims to combat rising inflation which hit a four-year peak in May 2017.
Elsewhere,
despite subdued inflation reading15, improving economic prospects in the US as
well as concerns over equity valuation raises the prospect of both rate hikes
and a gradual retrenchment of the US Fed’s $4.5 trillion balance sheet of the
bond holdings amassed during the financial crises. Set against dovish policies
across other developed markets (ECB and BoJ), a tighter monetary policy in US
increases probability of exchange rate volatility across EM currencies.
Overlaying the foregoing with the adoption of accommodative monetary policies
in key EM countries (Brazil, India, and Russia), the scale of capital flows to
EM debt market should be more subdued as the pull attraction from these key
destinations dim.
Scanning
across the various regions, EM Asia should be impacted by recent worries in the
Korean Peninsula. In the wake of North Korea’s latest long range ballistic
missile testing, which can reach Alaska in the US, there is now a growing
potential for increased militarisation in the region. Given the possibility of
an escalated conflict, foreign investors are likely to reduce their exposure to
the continent’s assets.
Elsewhere,
whilst MSCI’s decision to add 222 Chinese stocks to its emerging market
benchmark in 2018 could spur foreign demand for Chinese stocks in the medium
term, portfolio flows are likely to be adversely impacted by the potential
slowdown of the Chinese economy in the wake of recent monetary tightening by
the PBoC as well as Moody’s downgrade of the country’s credit ratings to (A1
from Aa3). However, as demonetisation-induced slowdown in India’s economy
continues to dissipate, improved growth outlook should drive higher FPI flows
to India.
Across
EM Europe, uncertainties surrounding Brexit negotiations which commenced in
June, and political worries in Germany which is scheduled to hold its Federal
election in September, should weigh on investors’ sentiment. Elsewhere in the
region, recent downtrend in commodity prices as well as lingering imposition of
western sanctions on Russia should accelerate the pace of capital outflow from
the country.
In
Latin America, the corruption charges levied against President Temer, a stark
reminder of the political crises that ousted the Brazil former President, Dilma
Rousseff, should likely weigh on investment sentiment and by extension
portfolio flows. Elsewhere, uncertainties surrounding the NAFTA renegotiation,
which should commence in August 2017, together with political considerations
ahead of next year’s elections, should trigger dollar outflows from Mexico.
Over
to the Middle East, in addition to the effect of lower oil prices, the
diplomatic rift between Saudi Arabia, UAE, Egypt, and Bahrain, on one hand, and
Qatar on the other, should dominate investors’ sentiment to the region’s
assets.
Given
the recent downturn across commodities, Eurobond issuance by Sub-Saharan
African countries is expected to decline as countries reduce FX exposure and
stabilize their debt ratios. In South Africa, concerns on the economic front,
prospects of further credit rating downgrades as well as political worries
ahead of the ruling ANC leadership contest and, by extension, the 2018 general
election should dampen the pace of portfolio flows to the country. In contrast,
foreign investors should continue to cheer the recently liberalized FX market
in Nigeria which, together with elevated interest rate environment and
improving economic picture, bodes well for capital flow to the country.
On balance, we expect the impact of hawkish monetary policy outlook in the US as well as the UK, aided by the rising spate of political uncertainties across the various regions, to moderate growth induced rise in portfolio flows to EM markets.
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