Foreign investors pulled money out of emerging markets for five straight months in the longest withdrawal streak on record, underscoring how recession fears and rising interest rates are shaking emerging economies.
Cross-border outflows by international investors in EM stocks and local bonds reached $10.5 billion this month, according to provisional data compiled by the Institute of International Finance. That took the flow over the past five months to more than $38 billion — the longest period of net outflows Since then, the records began in 2005.
The outflows may exacerbate the growing financial crisis in developing economies. In the last three months Sri Lanka has lost its sovereign debt and Bangladesh and Pakistan have both Contact the IMF for help A growing number of other emerging market issuers are also at risk, investors fear.
Many low- and middle-income developing countries are suffering from currency depreciation and borrowing costs, driven by interest rate hikes by the US Federal Reserve and fears of a recession in major advanced economies. USA this week recorded Its second consecutive quarterly output contraction.
“EM has had a really, really crazy rollercoaster year,” said Karthik Sankaran, senior strategist at Corpay.
Investors have also pulled $30 billion so far this year from EM foreign currency bond funds, which invest in bonds issued in the capital markets of advanced economies, according to JPMorgan data.
The foreign-currency bonds of at least 20 frontier and emerging markets trade at yields more than 10 percentage points above those of similar U.S. Treasury bonds, according to JPMorgan data compiled by the Financial Times. Spreads at such high levels are often seen as an indicator of severe financial stress and risk of default.
This marks a sharp reversal in sentiment from late 2021 and early 2022, when many investors expected emerging economies to rebound strongly from the pandemic. Already in April of this year, currencies and other assets in EM commodity exports such as Brazil and Colombia performed well against the backdrop of rising oil and other commodity prices following Russia’s invasion of Ukraine.
But fears of a global recession and inflation, aggressive US interest rate hikes and slowing Chinese economic growth have seen many investors exit EM assets.
Jonathan Forton Vargas, an economist at the IIF, said cross-border withdrawals were unusually common in emerging markets; In previous chapters, outflow from one region is partially offset by inflow into another.
“This time, the sentiment is generalized on the negative side,” he said.
Analysts also warned that unlike previous episodes, there is no immediate prospect of a change in global conditions in favor of EM.
“The Fed’s stance appears to be very different from previous cycles,” said Adam Wolff, EM economist at Absolute Strategy Research. “She is more willing to risk a recession in the US and to risk undermining the financial markets in order to lower inflation.”
There is also little sign of economic recovery in China, the world’s largest emerging market, he warned. This limits its ability to drive recovery in other developing countries that rely on it as an export market Finance source.
“China’s financial system is under stress from the economic downturn of the last year and that has really limited the ability of its banks to continue to refinance all their loans to other emerging markets,” Wolff said.
Sri Lanka’s default on its foreign debt has left many investors wondering who will be the next sovereign borrower to enter restructuring.
Spreads on U.S. Treasury bonds over foreign bonds issued by Ghana, for example, have more than doubled this year as investors price in the growing risk of a default or restructuring. Very high debt service 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, a rate of $1 billion per quarter.
If that continues, “over four quarters, all of a sudden reserves will be at levels where the markets start to really worry,” said Kevin Daly, chief investment officer at Aberdeen. The government is almost certain to miss its fiscal targets for this year and so the drain on reserves should continue, he added.
Credit costs for large EMs such as Brazil, Mexico, India and South Africa have also increased this year, but by less. Many major economies acted early to fight inflation and put policies in place to protect them from external shocks.
The only major EM of concern is Turkey, where government measures to support the lira while refusing to raise interest rates – in effect, promising to pay local depositors the currency devaluation cost of sticking to the currency – have a high fiscal cost.
Such measures can only work when Turkey runs a current account surplus, which is rare, Wolff said. “If it needs external funding, eventually these systems are going to break down.”
However, other major emerging economies face similar pressures, he added: Reliance on debt financing means that governments eventually have to suppress domestic demand to bring debt under control, risking recession.
Forton Vargas said there was little escape from the sale. “What is surprising is how strongly the sentiment has reversed,” he said. “Commodity exporters were investors’ darlings just a few weeks ago. There are no favorites now.”
Additional reporting by Kate Duguid in London
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