Recent pressure on emerging market currencies has rightfully made headlines. But the broader issue for emerging markets is that such episodes could easily reoccur, or even get worse, over the next few years. This is because, over the past decade, these economies have increasingly pinned their economic hopes to foreign capital flows.
The numbers speak for themselves; portfolio flows to the emerging markets have grown 400 per cent over the past 10 years, compared with nominal GDP growth of 200 per cent. And the same is true of the broader private capital measure, which also includes bank lending and direct investment. This has increased 5.5 times over the same period.
This increase in flows relative to GDP means capital withdrawals are now particularly painful in times of stress. Repeatedly, we have seen that investors’ fear of the unfamiliar results in a herd mentality, repatriating capital to more familiar domestic markets.