Commentary on Political Economy

Thursday 17 December 2020


Foreign investors dash into emerging markets at swiftest pace since 2013

During the past month, foreigners have invested almost $37bn in emerging market debt and $40bn in equities, IIF data show © FT montage

Foreign investors have piled into emerging markets this quarter at the most rapid clip in seven years, offsetting a record exodus from those countries’ stock and bond markets at the start of the coronavirus crisis.

Money is expected to continue pouring into the asset class in 2021, with several analysts forecasting a bumper year of inflows. But others warn that the economic outlook remains tough and that many businesses and governments will struggle to invest in productive growth.

Data from the Institute of International Finance prepared for the Financial Times show that more than $95bn left local stock and bond markets in March, with subsequent cross-border flows bringing the total outflow to $243bn in the first four months of the crisis. 

Foreign investors then staged a return, slowly at first but accelerating to $145bn in November alone, according to the IFF. During the past month, foreigners have invested almost $37bn in emerging market debt and $40bn in equities, the data show.

Line chart of Cross-border flows in months following onset of crisis ($bn) showing Emerging markets have staged a powerful comeback

Jonathan Fortun Vargas, economist at the IIF, said the fourth quarter of 2020 was set to register the strongest flows to EM assets since the first quarter of 2013, just before the “taper tantrum” that caused a rush of outflows after the US Federal Reserve said it was preparing to rein in its ultra-loose monetary policies.

“Overall, the exodus of capital from emerging markets is now firmly in the rear-view mirror and robust inflows look set to continue,” he said.

This year, the Fed’s aggressive monetary stimulus in response to the pandemic has boosted financial assets around the world. The Fed and other central banks in advanced economies have injected an estimated $7.5tn into global financial markets during the crisis, according to the IMF.

Emerging market equities have been slow to catch up, with cross-border flows only turning positive in the past two months, according to the IIF. The debt market has posted a more vigorous recovery as investors chase returns with interest rates in the developed world sitting at record lows.

Data from EPFR, a Boston-based data monitor that tracks flows to mutual funds and exchange traded funds widely used by retail investors, tell a similar story, although equity funds and local currency bond funds have yet to recapture the money that flowed out earlier in the year.

Line chart of Cumulative flows to EM mutual funds and exchange traded funds ($bn) showing Flows to equity funds have surged in recent weeks

Analysts point to attractive valuations for EM equities, both historically and relative to developed market equities, and the boost to economic prospects from the earlier-than-expected arrival of coronavirus vaccines, in addition to supportive monetary policies worldwide.

“Emerging markets have started to outperform,” said Christopher White, equities fund manager at Somerset Capital Management. “We think there are good reasons to believe this will continue and 2021 could be a breakout year for emerging markets.”

Jacob Grapengiesser, partner at East Capital, said China and India stood out in terms of economic growth next year, while an expected resurgence in tourism would particularly benefit Turkey, Greece, Thailand and Malaysia.

Rising oil prices would be positive for Russia and Brazil, which have underperformed drastically this year, he added. Their equity markets have fallen 18 per cent and 21 per cent respectively so far in 2020, compared with a gain of more than 14 per cent for EM equities overall in dollar terms, according to index provider MSCI.

But others warned that the rally fuelled by the abundant cash in search of investments and the optimism over an end to the pandemic could run out of steam.

“This has been driven by the search for yield,” said Omotunde Lawal, head of emerging markets corporate debt at Barings. “China is recovering and people extrapolate that to the rest of EM. There is a lot of stimulus out there and EM is the natural place for yield.”

However, “reality will definitely bite next year,” she added. “People will spin it that growth is sequentially higher because it is coming from a low base. But the reality is that there won’t be a return to normal.”

Rahul Ghosh, senior vice-president at Moody’s, said the fiscal impact of coronavirus would be felt for several years to come, with government revenues across emerging markets falling by the equivalent of 2.1 per cent of economic output this year, more than double the fall in advanced economies.

“Capital spending will not be as significant in the fiscal mix as it was in the past, so the ability of governments to generate growth will be restrained,” he said.

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