Capital flows to emerging markets to surge to record $620 billion, IIF says

By Jennifer Chiou

New York, Oct. 22 - Net private capital flows to emerging markets are expected to reach a record $620 billion this year, up from a 2006 total of $573 billion, according to a report from the Institute of International Finance (IIF).

The report forecasts that private flows are likely to reach another high level in 2008 of around $600 billion.

"Emerging markets have demonstrated notable resilience in the face of the recent dislocations in global financial markets that were triggered by the U.S. subprime mortgage market crisis," Josef Ackermann, chairman of the IIF's board of directors and chairman of the management board and of the group executive committee of Deutsche Bank AG, said in a news release.

"The overall outlook for continued capital flows to emerging markets is positive. Looking back at the conditions that prevailed a quarter of a century ago when the outbreak of the Latin American debt crisis led to the establishment of the IIF, one sees remarkable progress by emerging markets' economies in strengthening their economic and financial fundamentals."

The IIF noted that emerging market economies in aggregate are continuing to register sizable current account surpluses.

China alone is likely to see a current account surplus of $380 billion this year and $450 billion next year, with its foreign exchange reserves reaching about $1.9 trillion by the end of 2008, the IIF said, adding that the foreign exchange reserves of the 30 leading emerging market countries are set to rise by $756 billion this year, after a gain of $554 billion in 2006, while a further rise of $707 billion is projected for 2008.

"To their credit, emerging markets are sustaining significant growth, consolidating their fiscal positions and building foreign exchange reserves. These are levels of performance that few people expected just a few years ago," William Rhodes, first IIF vice chairman, senior vice chairman, Citigroup Inc., and chairman, president, and chief executive officer, Citibank, NA, added in the release.

"However, vulnerabilities continue to persist as we look ahead. A further possible slowing of growth in the major economies could impact the emerging markets; there are risks of excessive asset price appreciation; a strengthening of inflationary pressures in a number of countries, which have to be resisted; and the potential of a disorderly foreign exchange markets, should not be ignored."

Bank lending set to fall

Commercial bank lending is the component of private capital flows most likely to be reduced by recent financial turmoil in the coming year, IIF said, projecting that net flows from banks are likely to fall in 2008 to $146 billion, from $189 billion in 2007 and a peak of $202 billion last year.

According to the report, the reduction reflects a combination of three factors: demand for borrowing from banks has declined; banks themselves have become far more cautious, especially since the onset of recent turmoil; and, "A final factor that will come into play in coming months will be the balance sheet constraints that banks in the major money centers are faced with across the board as they are required to expand their assets rapidly as a result of commitments to fund both LBOs and asset-backed conduits and SIVs. This will reduce credit availability for all borrowers, emerging markets included."

Foreign direct investment flows into emerging market economies continue to account for the largest share of capital flows with the IIF projecting these to rise to $213 billion this year, up from $167 billion last year, the report said. A further gain to $223 billion is projected for 2008.

Debt financing rises

The IIF projected that debt-related flows from non-bank private sector sources will remain steady in 2008 at about the same volume of 2007 at $170 billion, after $141 billion last year.

The report said that these flows have been dominated by flows to emerging Europe, and this is expected to persist with about two-thirds of total flows going to this region, of which $42 billion is projected for Russia mainly bond issues by domestic banks and corporations.

The regional data in the report showed that emerging Europe is set to continue to obtain the largest volume of net private capital flows, well ahead of emerging Asia.

The IIF is the global association of financial services firms with more than 370 member institutions.

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