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Emerging markets hit by record streak of withdrawals by foreign investors

Foreign investors have withdrawn money from emerging markets for the fifth straight month in a row with the longest withdrawals ever, highlighting how concerns about recession and rising interest rates are shaking the developing economy. ..

Cross-border outflows of EM equities and domestic bonds by international investors reached $ 10.5 billion this month, according to preliminary data compiled by the Institute of International Finance. This has resulted in over $ 38 billion in outflows over the last five months. This is the longest net outflow period since the record began in 2005.

Outflows run the risk of exacerbating the growing financial crisis of the developing economy as a whole. In the last three months, Sri Lanka has defaulted on sovereign debt, and both Bangladesh and Pakistan have sought help from the IMF. Investors are concerned that more and more other issuers are also at risk across emerging markets.

Many low- and middle-income developing countries are suffering from currency depreciation and rising borrowing costs due to interest rate hikes by the Federal Reserve Board and concerns about the recession in major advanced economies. The United States recorded a second consecutive quarterly decline in production this week.

Karthik Sankaran, Senior Strategist at Corpay, said:

So far this year, investors have withdrawn $ 30 billion from EM foreign currency bond funds investing in bonds issued in developed markets, according to JP Morgan data.

At least 20 frontier and emerging market foreign currency bonds are trading at yields of more than 10 percentage points higher than comparable US Treasuries, according to JPMorgan data collected by the Financial Times. Such high levels of spreads are often seen as an indicator of serious financial stress and default risk.

This represents a sharp reversal of sentiment from late 2021 to early 2022, when many investors expected emerging economies to recover significantly from the pandemic. By April of this year, the currencies and other assets of commodity export EMs such as Brazil and Colombia were strong against the backdrop of rising oil and other raw material prices after Russia’s invasion of Ukraine.

However, concerns about a global recession and inflation, aggressive rises in US interest rates, and slowing China’s economic growth have forced many investors to withdraw from EM assets.

IIF economist Jonathan Fortun Vargas said cross-border withdrawals have been extraordinarily widespread throughout emerging markets. In previous episodes, outflows from one region were partially balanced by inflows into another.

“This time, sentiment is generalized on the downside,” he said.

Analysts also warned that, unlike previous episodes, there is little immediate prospect that the global situation will benefit EM.

“The Fed’s position seems to be very different from the previous cycle,” said Adam Wolfe, EM economist at Absolute Strategy Research. “It is more aggressive to risk the US recession and destabilize financial markets to reduce inflation.”

He warned that there are few signs of economic recovery in China, the world’s largest emerging market. It limits the ability to drive recovery in export markets and other developing countries that trust it as a source of funding.

“China’s financial system has been affected by last year’s economic downturn, really limiting banks’ ability to continue refinancing all loans to other emerging markets,” Wolff said.

Sunday’s report highlighted concerns about the strength of China’s economic recovery. The Official Purchasing Managers Index for Manufacturing dropped from 50.2 in June to 49 in July, surveying executives on topics such as production volume and new orders.

Reading suggests that activity in the country’s vast factory sector, which is the main growth engine for broader emerging markets, has fallen into a shrinking territory. According to Goldman Sachs economists, this decline was due to “sluggish market demand and reduced production in energy-intensive industries.”

Meanwhile, due to Sri Lanka’s default on external debt, many investors are wondering who will be the next sovereign borrower to enter restructuring.

For example, US Treasury bond spreads over foreign bonds issued by Ghana have more than doubled this year as investors value increased risk of defaults and restructuring. Very high debt repayment costs are eroding Ghana’s foreign exchange reserves, dropping from $ 9.7 billion at the end of 2021 to $ 7.7 billion at the end of June, at a quarterly rate of $ 1 billion.

If that continues, “for more than four quarters, reserves will suddenly reach a level where the market really begins to worry,” said Kevin Daly, investment director at Abrdn. He added that reserves will continue to be depleted as the government is almost certainly unable to meet this year’s fiscal goals.

Borrowing costs for large EMs in Brazil, Mexico, India and South Africa have also risen this year, but less. Many great powers acted early to combat inflation and implemented policies to protect them from external shocks.

Turkey is the only major EM of concern, and the government has taken steps to support Lira while refusing to raise interest rates, effectively giving local depositors currency depreciation to maintain their currency. I promise to pay.

According to Wolff, such measures only work while Turkey is in the current account surplus. “If you need external funding, those systems will eventually stop working.”

But other large emerging economies are facing similar pressure, he added.

Fortun Vargas said there were few escapes from the sale. “What’s amazing is how strongly the emotions are reversed,” he said. “Commodity exporters were investors’ darlings just a few weeks ago. Currently, there are no darlings.”

Additional report by Kate Duguid in London

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