Outflows from emerging markets are getting more severe

As monetary tightening picks up pace, global investors are shunning emerging market (EM) assets. This is not surprising as the rate hiking cycles have punched a hole in performance of EMs. Besides, this time around, investors have to also deal with quantitative tightening.

This fear of investors is well captured in the Bloomberg Emerging Market Capital Flow Proxy Index. At 144 points, the index is below its long-term average of 146. The Bloomberg Emerging Market Capital Flow Proxy Index is a daily composite index of the performance of four asset classes that appears to mimic the flow of money in and out of EMs. The index is constructed using the Goldman Sachs Commodity Index, MSCI EM Equity Index, Emerging Markets Bond Index spreads (relative to value on 7 January, 2005) and EM FX Carry Trade Index.

Steep outflow

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Steep outflow

The proxy index mirrors the rising risk aversion among foreign investors regarding EM assets. With rising interest rates, global bond yields have inched up. Note that a fallout of rising interest rates is higher cost of capital for corporates. Also, with high crude oil prices, EMs become less attractive for foreign institutional investors (FIIs) because of the unfavourable macro impact on their economies. Unfortunately, more pain lies ahead for EMs.

High inflation will erode household real incomes sufficiently to result in a slowdown in global growth, said Kieran Tompkins, assistant economist at Capital Economics. “There are already signs that this weakening in demand will prompt a decline in global trade. That would pose another headwind to EM equities, as downturns in export growth have often gone hand-in-hand with slowing, or falling, earnings growth,” Tompkins said in a report on 20 June. “On top of that, the ongoing shift in global consumption patterns away from goods towards services might be an additional headwind to indices in Asia in which the shares of electronics exporters have a large weight,” he said.

So far in CY2022, the MSCI Asia Ex-Japan index and the MSCI Emerging Market index have fallen by about 18% and 19%, respectively. True, key equity indices in developed markets have seen a higher correction. However, the outlook for EMs is loaded with challenges. Apart from inflation and slowing global growth, investors should also keep an eye out for the resurgence of covid-19.

“As if the state of the global economy wasn’t challenging enough, it looks like covid-19 is slowly creeping back into the agenda in Emerging Asia,” said Miguel Chanco, chief emerging Asia economist at Pantheon Macroeconomics in a report on 20 June. Chanco is not sounding alarm bells on this yet, but notes renewed concern stems from a steady rise in cases.

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