RSS FeedBy M. Isi Eromosele
Overall, net capital flows to emerging countries were down last year for the second year in a row. The decline has occurred primarily in the capital flows from the private sector, particularly in the debt component (both banks and bonds). This weakness in the private sector indicates that the whole context for development financing has shifted. As borrowers have chosen or been required by their creditors to pay down their debts, the external debt of many emerging countries has fallen in dollar terms.
Rotation From Debt To Equity
As debt is being repaid to private sector creditors, net equity inflows to emerging countries remain significant, mainly through the route of FDI. Net inward FDI flows did slow in 2008, with most of the slowdown occurring in Latin America. By contrast, flows to China picked up in response to its strong growth and optimism, following China’s accession to the World Trade Organization (WTO).
The shifting pattern of private flows - debt down, equity up - has had an important implication for the associated stock of debt. While stock of emerging-country external debt outstanding from all sources has fallen since 2008, the stock of equity capital owned and controlled by foreigners has risen sharply. The relative dependence on external equity is highest in East Asia and the Pacific, apparently reflecting the influence of China, where the external debt equity has fallen below 50 percent.
The shift stated above is partially driven by investor preferences. Debt investors, both banks and bond-holders, have become more wary of holding debt claims on emerging countries, whereas non-financial corporations have come to increasingly believe that the emerging world offers significant growth opportunities both as an export platform and as a source of domestic consumption.
On balance, the shift is a positive development. For many countries, the fundamental rotation in capital flows is growing to be very challenging indeed. This is because the current account balance must move into surplus in order to generate the foreign exchange needed to pay down external debt. Nevertheless, the rotation should be seen as a constructive development because it puts development finance on a stable platform.
When macroeconomic conditions within an emerging country changes for the worse, debt markets rightly factor in more risk and consequently resort to charging more for debt capital. The result is increased strain on the country and a greater likelihood of financial crisis and default. In contrast, the financing of growth and development through direct equity participation builds shock absorbers into what is usually an unequal process.
Near Term Prospects
If the global economy experiences strong expansion in the years ahead, foreign direct investors will likely continue to build their holdings in emerging countries. In such a scenario, debt investors will probably also return in earnest to emerging nations. As such, the main challenge that policy makers would face is to avoid the excesses of near-term debt growth that had led to serious problems in the past.
If the global economy remains weak, it will elicit further pause from FDI investors and debt investors are liable to persevere in quickening their pullback. This scenario is more plausible where global economic stagnation turns out to be more severe and protracted than currently anticipated.
If, as the current forecast predicts, the global economy continues a slow but consistent recovery, both FDI and debt investors will remain cautious. Net FDI inflows are likely to pick up in 2012-2013 in line with a modest revival in global investment. Net debt flows will remain subdued, although they should turn positive in 2013. The gains will be led by bond investors, for whom the high yields offered by emerging country debt will be relatively attractive. By contrast, net debt repayments to banks will continue, as banks remain under pressure as they make strenuous efforts to reduce their risk exposures.
M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance
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