Foreign investors have withdrawn funds from emerging markets for five straight months in the longest withdrawal streak on record, underscoring how recession fears and rising interest rates are rattling developing economies.
Cross-border outflows by international investors in emerging-market stocks and domestic bonds reached $10.5 billion this month, according to provisional data compiled by the Institute of International Finance. That brought outflows for the past five months to more than $38 billion, the longest period of net outflows since records began in 2005.
Exits risk exacerbating a growing financial crisis in developing economies. In the last three months Sri Lanka has defaulted on its sovereign debt and Bangladesh and Pakistan have approached the IMF for help A growing number of other issuers in emerging markets are also at risk, investors fear.
Many low- and middle-income developing countries are suffering from depreciating currencies and rising borrowing costs, fueled by rate hikes by the US Federal Reserve and recession fears in major economies. advanced economies. United States this week Recorded its second consecutive quarterly contraction in output.
“EM has had a really crazy rollercoaster year,” said Karthik Sankaran, senior strategist at Corpay.
Investors have also raised $30 billion so far this year from emerging-market foreign-currency bond funds, which invest in bonds issued in the capital markets of advanced economies, according to data from JPMorgan.
Foreign-currency bonds from at least 20 frontier and emerging markets are trading at yields more than 10 percentage points above comparable U.S. Treasuries, 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 default risk.
It marks a sharp shift in sentiment from late 2021 and early 2022, when many investors expected emerging economies to rebound strongly from the pandemic. In April this year, currencies and other assets in commodity-exporting emerging markets such as Brazil and Colombia performed well on the back of rising oil and other commodity prices following the Russian invasion of Ukraine.
But fears of a global recession and inflation, aggressive US interest rate hikes and a slowdown in Chinese economic growth have caused many investors to turn away from emerging market assets.
Jonathan Fortun Vargas, an economist at the IIF, said cross-border withdrawals had been unusually widespread in emerging markets; in previous episodes, exits from one region have been partially offset by entries to another.
“This time, sentiment is broadly to the downside,” he said.
Analysts also warned that, unlike previous episodes, there was little immediate prospect of global conditions turning in favor of emerging markets.
“The Fed’s position appears to be very different from previous cycles,” said Adam Wolfe, emerging markets economist at Absolute Strategy Research. “He is more willing to risk a US recession and to risk destabilizing financial markets to reduce inflation.”
There are also few signs of an economic recovery in China, the world’s largest emerging market, he warned. That limits its ability to fuel a recovery in other developing countries that depend on it as an export market and a funding source.
“China’s financial system is under pressure from last year’s economic downturn and that has really limited the ability of its banks to continue to refinance all of their loans to other emerging markets,” Wolfe said.
Sri Lanka’s foreign debt default has left many investors wondering who will be the next sovereign borrower to restructure.
Spreads on US Treasuries over foreign bonds issued by Ghana, for example, have more than doubled this year as investors price in a growing risk of default or restructuring. Sky-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, “for four quarters all of a sudden reserves are going to be at levels where markets are really going to start worrying,” said Kevin Daly, chief investment officer at Abrdn. The government will almost certainly miss its fiscal targets for this year, so the drain on reserves will continue, he added.
Borrowing costs for big emerging markets such as Brazil, Mexico, India and South Africa also increased this year, but by less. Many large economies acted early to fight inflation and pursued policies that protect them from external shocks.
The only major EM of concern is Turkey, where government moves to support the lira while refusing to raise interest rates—in effect, promising to pay local depositors the currency-depreciating cost of holding the currency — have a high fiscal cost.
Such measures can only work as long as Turkey runs a current account surplus, which is rare, Wolfe said. “If you need external financing, eventually those systems will collapse.”
However, other large emerging economies face similar pressures, he added: reliance on debt financing means governments eventually have to suppress domestic demand to control debts, risking recession.
Fortun Vargas said there was little escape from liquidation. “What’s surprising is how strongly sentiment has changed,” he said. “Commodity exporters were investors’ darlings just a few weeks ago. There are no loved ones now.
Additional reporting by Kate Duguid in London