Emerging market FX reserves again on rise
One of the big stories of the past decade, that of staggering reserve accummulation by emerging market central banks, appeared to have ground to a halt as global trade and economic growth slumped. But according to Bank of America/Merrill Lynch, reserves are starting to grow again for the first time since mid-2011.
The bank calculates that reserve accumulation by the top-50 emerging central banks should top $108 billion in September after strong inflows of around $13 billion in each of the first two weeks. Look at the graphic below.
So what is the source of these inflows? As BoA/ML points out global trade balances are at their cyclical lows and that is reflected in the dwindling current account surpluses in the developing world. But as risk sentiment has improved in the past six weeks, there has been a pick up in fixed income and equity investment flows to emerging markets, compared to the developed world.
These portfolio flows are likely to increase even more following the Fed’s announcement of an open-ended $40 billion-a-month money-printing programme. BoA/ML writes:
The data show that investment capital is being rotated out of developed markets to EM, supporting our view that the financial account has been increasing, even if the current account has not…..Real money flows explain a large share of the recent growth in reserves.
In particular bond inflows to emerging markets have seen a significant rise and according to BoA/ML, they account for 40 percent of reserve growth on a currency-adjusted basis (up from 30 percent since 2001).
That has significant implications for reserve currencies such as yen, euro and the dollar because EM central banks will need to reinvest these additional reserves. That, according to BoA/ML, heralds a continuation of low volatility for G10 currencies which tend to benefit from this during periods of reserve growth in emerging markets.