Capital Flowing Out of Developing Countries

by Chris Sturr | March 18, 2009

From Nouriel Roubini’s RGE Monitor:

The reversal of capital inflows due to deleveraging or losses in financial markets has been one of the most significant effects of the financial crisis on emerging and frontier economies. After a period in 2007 and 2008 when many emerging markets faced the problem of dealing with extensive capital inflows, now capital flows have reversed. Private capital flows in 2009 are expected to be less than half of their 2007 levels, posing pressure on emerging market currencies, asset markets and economies. Countries that relied on readily available capital to finance their current account deficits are particularly vulnerable. Furthermore, capital outflows pose the risk that governments may react with some type of capital controls or barriers to the exit of foreign investments.

Note that the piece later adopts a different tone on capital controls, accepting their use on a temporary basis and noting that Iceland, Ukraine, Argentina, Indonesia and Russia, among others, have already adopted them.

Foreign direct investment (FDI) is considered by many to be a major and more stable source of financing for many developing countries. FDIs slowed down sharply in recent quarters …

The outlook for the flow of portfolio investments is even less encouraging. … About half of the EM [emerging market] fund purchases that have occurred since 2003 have now been withdrawn. According to the Institute for International Finance (IIF), net private capital flows to emerging markets are estimated to have declined to US$467 billion in 2008, half of their 2007 level. A further sharp decline to US$165 billion is forecast for 2009 …

The World Bank estimates that in 2009, 104 of 129 developing countries will have current account surpluses inadequate to cover private debt coming due. …

With rising unemployment and falling real wages, remittances will also subside with pressure on the standard of living, growth and external balances of labor-sending countries. In addition to these private capital flows the reduction of official flows, including development assistance is also set to slow as donors scale back their funding in the face of greater domestic needs. However funds available from multilateral institutions like the IMF and regional development banks may partly offset the decline in other funds and withdrawal of private capital. The G20 seems to have neared an agreement on doubling or tripling the IMF’s lending capacity and regional development banks like the EBRD, ADB and others are boosting their capital base and scaling up their lending to support regional banks. …

Read the whole analysis here.

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