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Portfolio bond flows: each BRICS country has its own story!


Since 2013, and especially since Ben Bernanke's "taper tantrum" announcement, the emerging economies have seen massive capital outflows that are still important. However, the situation differs from country to country.

Narrowing the focus to the BRICS countries, it appears that besides a common trajectory linked to commodity prices and the slowdown of China's economy, the capital outflows by residents and non-residents can be attributed to specific shocks in each country. Can we expect the situation to improve for these countries, particularly the BRICS nations, in 2016?



The economic, political and geopolitical environments do not bode well for capital inflows to the emerging economies

In the text titled "Capital flows to the emerging markets" published in the November 2015 Cross Asset publication (page 55), it was shown that portfolio capital flows towards emerging markets fell by a further 25% this year. This analysis is grounded in estimates based on EPFR data. Though limited in scope, these data provide a good approximation of trends in portfolio flows according to several academic studies.

Several factors appear to be at the origin of these massive outflows. The sharp decline in commodity prices, uncertainties surrounding the slowdown in China and the normalisation of the Fed's monetary policy are all common factors that have had a negative impact on these flows. But in addition to these economic shocks, which have affected the majority of the emerging countries, there have also been a number of specific shocks of a political and/or geopolitical nature, such as the Ukrainian crisis, elections in a number of countries and the political crisis in Brazil.

This article focuses on the bond markets of the BRICS countries and attempts to highlight potential divergences between the capital flows of residents and those of non-residents. As a first step, it is worth drawing a parallel between Brazil, Russia and South Africa. All of these are net exporters of commodities and are therefore vulnerable to the price changes observed on these markets, as well as to the slowdown in China, the leading importer of the same commodities. As they have also been affected by specific shocks of a political or geopolitical nature, it is also worth analysing whether these shocks have had an influence on portfolio investment decisions. Then, China and India will be put into perspective.

Brazil: the political crisis has overshadowed the economic crisis

In Brazil, portfolio investment outflows began very early, before Bernanke's "taper tantrum" announcement in the summer of 2013. Indeed, ever since the 2008 crisis, Brazil's economy has been on life support in the form of fiscal stimulus, accommodating monetary policy, increased subsidies to domestic companies and increased lending, among other measures. By 2013, the economic situation was already gloomy, with real GDP growth at 2%, high unemployment, increasing inequality and raging corruption scandals. President Dilma Rousseff's popularity began deteriorating, as did the confidence of investors, both domestic and foreign. From that point, Brazil's political and economic problems only got worse. Capital outflows became more and more massive and did not stop growing. According to our estimates (based on EPFR data), 70% of these outflows can be attributed to non-residents. It is clear that these capital outflows have been exacerbated by the sharp decline in commodity prices, and it may be tempting to conclude a strong causal link between the two. But this analysis may be partially incorrect. In fact, the capital outflows appear to be more strongly related to the fragility of Brazil's economic fundamentals, situation aggravated by the fall in commodity prices and the current political crisis.

Looking ahead to 2016, given the catastrophic course of the political crisis (demands of Dilma Rousseff's impeachment, series of arrests of politicians from across the political spectrum for corruption charges and the resignation of highly respected Finance Minister Joaquim Levy) and poor prospects for improved global growth, the trend seen since early 2013 is not likely to reverse any time soon.

Russia: the massive capital outflows are primarily driven by residents and related to the Ukrainian crisis

The breakdown of capital flows between residents and non-residents is particularly instructive in the case of Russia. First of all, the capital outflows by residents are mainly related to the crisis in Ukraine. Resident capital inflows began diminishing from the beginning of the conflict in November 2013. By spring 2014, massive capital outflows could be observed. Since then, despite the high volatility of commodity prices, we have not seen an expansion of this phenomenon. When it comes to non-resident capital, the story is not at all the same. As in Brazil, capital outflows by non-residents began occurring in early 2013. But the similarities end there. In fact, despite the shocks that have affected Russia and continue to do so (conflict with Ukraine and the fall in commodity prices), capital outflows by non-residents have stabilised. There were even renewed inflows by non-residents in the spring of 2015, when the price of oil saw a slight rebound. Since summer, undoubtedly due to the uncertainties surrounding China's slowdown and the commodity markets, we have seen new capital outflows by non-residents. But so far, these have remained minimal. Nonetheless, if the price of oil were to decline further and persist in a downward direction, we cannot exclude the possibility of increased capital outflows from Russia.

South Africa: the slowdown in China appears to be the key trigger

While portfolio flows appeared to be relatively stable or even slightly rising for domestic investors in the first half of 2015, the summer of 2015 heralded a change of regime, with major capital outflows by residents and non-residents alike. This coincided with the sharp drop on China's equity markets and the devaluation of the yuan. Thus it may well be that investors, faced with the uncertainty of China's slowdown and given the strong trade and financial links between South Africa and China, re-evaluated South Africa's level of risk. And as long as major doubts remain about the stabilisation of China's economy and commodity prices, South Africa could struggle to attract investment. President Zuma's actions during the week of 14 December only detracted from the credibility of the South African authorities, and consequently of their economic policy. Zuma had originally sacked his Minister of Finance and replaced him with a little-known backbencher. But under the pressure of the markets and rating agencies, he back-pedalled four days later and appointed a former Minister of Finance, Pravin Gordhan, known for his orthodox approach. While the change is a positive sign, the damage has already been done; at the very least, doubt has been cast on the integrity of the President, who has already been involved in numerous scandals and corruption cases. And with the fall in the commodity prices, South Africa's mining industry has been heavily impacted, with mass redundancies occurring. This raises the spectre of a social crisis, which could make it impossible for the Minister of Finance to implement the necessary reforms.

China: the bursting of the bubble on the equity markets in the summer of 2015 has undermined the confidence of foreign investors

Foreign investors, who have a limited presence on China's highly-regulated equity markets, have invested massively in the bond markets over recent years. But the bursting of the speculative bubble on the Chinese equity markets in the summer of 2015, coupled with the devaluation of the yuan, have raised new questions about the slowdown in China and led to significant capital outflows, affecting all of the emerging Asian equity markets in a mostly indiscriminate fashion, with China the hardest hit. This erosion of confidence was very quick to affect the Chinese bond markets. Solely in the month of August 2015—seen as the tail end of the equity market crash—a massive trend reversal occurred, with nearly $1.5 billion evaporating via foreign capital outflows alone (according to EPFR data). Then, concerns about the slowdown of China's economy were overshadowed by debates about the inclusion of the yuan in the basket of currencies that make up the IMF's Special Drawing Rights (SDR). In November 2015, the yuan joined the four traditional reserve currencies with a 14% weighting in the basket. Responding to the inclusion of China's currency in the SDR and the prospect of a renewed fall in oil prices, foreign investors began returning to the bond markets, taking advantage of a calm end to the year as more positive macroeconomic news flowed in from China. 

India: the country has been spared by the capital outflows, with foreign investors maintaining a limited presence on the bond markets 

In India, from a macroeconomic point of view, 2015 has been marked by the consolidation of public finances, which, coupled with the drop in inflation, has opened the door to monetary easing. Thanks to the regained credibility of the Reserve Bank of India (RBI) and the change in political and economic direction under the administration of Narendra Modi, India is increasingly being called the "new China". Indeed, the rebalancing of budgetary and monetary policies represents clear support for growth, and India has seen its growth forecasts raised for 2016 (+7,4% in our central scenario as for the consensus) and 2017 (+7,2% in our central scenario and +7,7% for the consensus). Furthermore, the fall in oil prices is a great boon for India, as it implies a de facto drop in inflation, a reduction in the budget deficit given that India is a major importer of oil and, consequently, a reduction of the trade deficit. In the space of merely two years, India has evolved from one of the "Fragile Five" to the investment case of 2015. And it has been able to attract capital, primarily domestic, to its bond markets. 2016 should follow in the footsteps of 2015, with a continuation of capital inflows—perhaps with an increase from foreign investors—assuming no major external shocks intervene.

In terms of bond portfolio flows for the BRICS countries, 2016 will bring mixed fortunes

The massive portfolio outflows from the BRICS bond markets in 2015 are all linked to low commodity prices and concerns surrounding the slowdown of China's economy. However, each BRICS country has also experienced idiosyncratic shocks of a political and/or geopolitical nature, exacerbating the capital outflows. And whereas India has been the investment case of 2015, its economic success rewarded by significant capital inflows, Brazil, Russia, China and South Africa have all been affected by specific shocks. Having studied the specific situation in each country, it appears more than likely that Brazil and South Africa will remain bogged down by their political problems, with the further risk of social crises erupting. Thus, capital outflows from these countries should continue in 2016. In the case of Russia, the easing of the Ukrainian crisis and the relative stability of oil prices could be conducive to a return of portfolio inflows, particularly on the part of domestic investors. In China, as of late 2015 portfolio inflows are already starting to return, and 2016 could be a decisive year for domestic investors. Finally, India could see the upward trend observed in 2015 persist into 2016.


Since 2013, the emerging economies have been weakened by massive capital outflows




Oil does not tell the whole story!

Political and geopolitical crises are much stronger catalysts




China's slowdown is also an important factor




India has become the investment case of the year




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Cross Asset of January 2016 in English

Cross Asset de Janvier 2016 en Français

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HERVE Karine , Emerging Markets Senior Economist
MOUSSAVI Julien , Strategy and Economic Research at Amundi
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Portfolio bond flows: each BRICS country has its own story!
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