The downside of investment inflows? Outflows
What goes in, can come out. And the more that goes in, the more than can come out. That’s what emerging economies have been finding out in recent weeks as capital flees their stock and bond markets.
Take the case of Russia. It’s decision last year to allow foreigners to access its domestic bonds more easily led to a boom in its OFZ or rouble debt, market, with many analysts reckoning OFZs could receive inflows of almost $50 billion in 2013-2014.
Analysts at RBS calculate some $24 billion was received in the past 18 months by OFZs but in the words of outgoing central bank Governor Sergei Ignatyev, recent outflows have been “very heavy”. Yields on Russia’s 10-year bond have jumped 120 bps since early June.RBS analysts write
This is the shape of things to come: with investors getting better access to local bonds via the international clearing systems, local bond prices and rouble as a consequence will become increasingly prone to fluctuations at the times of sharp global market moves.
But these are hard times, and competition for capital is actually inducing more and more emerging markets to open up capital markets to foreigners. Brazil for instance scrapped the taxes that have kept foreign participation in its bond markets well below the emerging market average. India and China both have strict curbs in place but have been loosening them.
India in particular, worried about financing its current account deficit, has been rapidly expanding bond investment quotas available to foreigners, hoping to attract more capital. This week it raised investment limits for long term foreign investors six-fold. This policy is not without dangers — India’s relative isolation so far has protected its bond markets from excessive volatility, says Steve O’Hanlon, head of fixed income at ACPI Investment Managers.
In 2008, India did not see a huge outflow of capital that upset the local yield curve. Ultimately allocation to foreigners is still small, nowhere like Indonesia for example. And the current account deficit won‘t disappear if you get more fixed income investment. They need to make structural changes to the economy otherwise they will just be hiding the problem.
There’s probably a lesson there for all emerging markets.