Emerging markets hit a record series of withdrawals by foreign investors

Emerging markets hit a record series of withdrawals by foreign investors

Foreign investors have withdrawn money from emerging markets for five consecutive months in the longest series of withdrawals ever, highlighting how recession fears and rising interest rates are shaking developing economies.

Cross-border outflows by international investors in emerging market stocks and local bonds totaled $10.5 billion this month, according to interim data compiled by the Institute of International Finance. This has increased outflows over the past five months to more than $38 billion – the longest period of net outflows since records began in 2005.

Outflows may exacerbate the escalating financial crisis across developing economies. In the past three months, Sri Lanka has defaulted on its sovereign debt, and Bangladesh and Pakistan alike have defaulted. Closer to the International Monetary Fund for help. Investors fear that a growing number of other emerging market issuers are also at risk.

Many low- and middle-income developing countries are suffering from currency depreciation and rising borrowing costs, driven by interest rate hikes by the US Federal Reserve and fears of a recession in major advanced economies. United States this week registered The second consecutive quarterly contraction.

“EM has had a really crazy year,” said Karthik Sankaran, chief strategist at Corpay.

Investors have also withdrawn $30 billion so far this year from emerging market foreign currency bond funds, which invest in bonds issued in capital markets in advanced economies, according to data from JPMorgan.

The forex bonds of at least 20 frontier and emerging markets are trading at yields more than 10 percentage points higher than comparable US Treasuries, according to JPMorgan data compiled by the Financial Times. Spreads at such high levels are often seen as an indication of severe financial stress and risk of default.

It represents a sharp reversal of sentiment from late 2021 and early 2022 when many investors expected emerging economies to recover strongly from the pandemic. In late April this year, currencies and other assets in commodity-exporting emerging markets such as Brazil and Colombia were doing well on the back of higher oil and other raw materials prices in the wake of Russia’s invasion of Ukraine.

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But fears of a global recession, inflation, steep rises in US interest rates and slowing Chinese economic growth have caused many investors to retreat from emerging market assets.

Jonathan Forton Vargas, an economist at the Institute of International Finance, said cross-border withdrawals were extraordinarily prevalent in emerging markets; In previous episodes, the outflows from one region were partially balanced by the outflows into another.

“This time around, sentiment is generally on the negative side,” he said.

Analysts also cautioned that, unlike previous episodes, there was little chance of global conditions turning in favor of emerging markets.

“The Fed’s stance appears to be very different from that of previous cycles,” said Adam Wolfe, emerging markets economist at Absolute Strategy Research. “They are more willing to risk a recession in the US and to risk destabilizing financial markets in order to bring down inflation.”

He warned that there were little signs of an economic recovery in China, the world’s largest emerging market. This limits their ability to drive recovery in other developing countries that depend on them as an export market and Funding source.

“The Chinese financial system has been under pressure from the economic downturn in the last year, and that has really limited the ability of their banks to continue to refinance all their loans to other emerging markets,” Wolf said.

Sunday’s report highlighted concerns about the strength of China’s economic recovery. The official manufacturing PMI, which polls executives on topics including production and new orders, fell to 49 in July from 50.2 in June.

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The reading suggests that activity in the country’s sprawling factory sector, a key growth driver for emerging markets more broadly, has fallen into contraction territory. The decline was due to “weak market demand and production cuts in energy-intensive industries,” according to economists at Goldman Sachs.

Meanwhile, Sri Lanka’s default on its external debt has left many investors wondering who will be the next sovereign borrower to begin restructuring.

Spreads on US Treasuries on foreign bonds issued by Ghana, for example, have more than doubled this year as investors have raised the risk of default or restructuring. Extremely high debt servicing costs are eroding Ghana’s foreign exchange reserves, which fell from $9.7 billion at the end of 2021 to $7.7 billion at the end of June, at a rate of $1 billion per quarter.

If that continues, “more than four quarters, reserves are suddenly going to be at levels where the markets are starting to really worry,” said Kevin Daly, chief investment officer at Abrdn. He added that the government will almost certainly fail to achieve its fiscal targets for this year, so the depletion of reserves is set to continue.

Borrowing costs for major emerging markets such as Brazil, Mexico, India and South Africa have also risen this year, but by a smaller percentage. Many large economies moved early to fight inflation and put in place policies that shielded them from external shocks.

The only big problem of concern is Turkey, where government measures to support the lira while refusing to raise interest rates — in effect, pledging to pay the cost of currency depreciation to domestic depositors for holding on to the currency — have a high financial cost.

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Wolf said such measures can only work at a time when Turkey is running a current account surplus, which is rare. “If they need outside funding, these systems will eventually collapse.”

However, other large emerging economies are facing similar pressures, he added: Reliance on debt financing means that eventually governments have to curb domestic demand to control debt, which could lead to a recession.

Fortune Vargas said there was little escape from the selloff. “What is surprising is how powerful the coup was,” he said. “Commodity exporters were darlings of investors just a few weeks ago. There are no darlings now.”

Additional reporting by Kate Dugwid in London

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