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Capital Flows to Emerging Market Economies

The strong recovery in net private capital flows to emerging markets that began in 2003 has continued this year. Although a moderation in the pace of flows is anticipated in the next several quarters, the overall level envisaged for 2006 remains relatively elevated. Downside risks have increased, however, in the face of rising concerns and unease about a potentially less hospitable global economic environment going forward. | Institute of ntemational inance Inc. Capital Flows to Emerging Market Economies September 24 2005 Overview The strong recovery in net private capital flows to emerging markets that began in 2003 has continued this year. Although a moderation in the pace of flows is anticipated in the next several quarters the overall level envisaged for 2006 remains relatively elevated. Downside risks have increased however in the face of rising concerns and unease about a potentially less hospitable global economic environment going forward. Private flows are projected to reach a record high 345 billion this year before slowing to 318 billion in 2006 Table 1 Chart 1 . This year s expected flows surpass the previous record of 323 billion reached in 1996 prior to the Asian crisis. The continued robustness in flows is being supported by a further pickup in direct investment and a record pace of bond issuance as sovereign and private borrowers endeavor to stay ahead of the curve before the tightening policy interest rate cycle starts to hit bond markets visibly. With many debtors having already taken the opportunity to pre-finance obligations due in 2006 the current pace of bond issuance is unlikely to be sustained next year contributing to an overall slowdown in private capital flows to emerging markets. This forecasted slowdown could become more pronounced if downside risks from a further jump in oil prices unanticipated policy slippage or other problems in a major emerging market economy or a sudden shift in investor risk aversion stemming inter alia from concerns over global imbalances or the fragility of global growth were to materialize. The strong private capital flows to emerging markets in 2005 has occurred against a backdrop of strong global economic expansion which has been supported by strong corporate profitability and buoyant housing markets in the United States and elsewhere. The measured but sustained monetary tightening in the United States has yet to dampen growth as