Slow and uncertain flows

Bigger outflow: Traders monitor stock prices at an investment bank in Kuala Lumpur. Malaysian equities saw outflow rising to RM2bil in September from RM1.5bil in the preceding month.

THE huge outflow of funds from emerging market (EM) investments in the final weeks of September could be a sign that a big “risk-off” is brewing.

The Institute of International Finance (IIF) says the data it tracks shows that the high frequency of outflows from EMs were almost as big as in the 2013 taper tantrum or during the 2015 Chinese yuan devaluation fears.

The global association of the finance industry says it also sees growing differentiation in flows to EMs, with some markets seeing outflows that continue to build, as well as an increasing divergence between debt and equity flows.

It notes that while debt flows to EMs last month posted an inflow of US$12.9bil, equities saw outflows of US$10.8bil, of which US$4bil were China equity outflows.

Overall, EMs attracted a net inflow of US$2.1bil last month amid a fresh bout of market turmoil, uncertainty arising from the US election, a rejuvenated dollar and lingering questions on the post-Covid-19 recovery path. This was more than the US$700mil net portfolio inflows seen in August.

In its latest capital flows report, the IIF projects a slow and uneven recovery for EM inflows, despite the severity of outflows at the height of the Covid-19 shock earlier this year.

“One underlying reason is that the growth recovery now is very different from during the aftermath of the global financial crisis, ” it says.

“Back then, China’s very big infrastructure stimulus lifted global growth and commodity prices, helping many EMs recover quickly. This stimulus is missing now, which is weighing especially on Latin America and capital flows to the region, ” it adds.

In general, the IIF expects a widely available Covid-19 vaccine to be the key positive catalyst for EM flows, as it will signal a positive global demand shock with favourable knock-on effects for commodity prices and global risk appetite.

Growth projection

IIF expects EM economies in general to shrink 2.4% this year before rebounding to a growth of 6.7% next year. In 2019, EM economies grew 3.8%.

By region, Latin American EM economies are expected to be the worst performers, with a decline in gross domestic product (GDP) of 8.4% in 2020 before returning to a growth of 3.8% in 2021. This is followed by Africa/Middle East EM economies, which are expected to shrink 5.5% in 2020, before growing 2.6% next year

Emerging Europe, on the other hand, is expected to see a GDP decline of 4.8% this year and a return to growth of 4.2% next year, according to the IIF.

As for Asia-Pacific EM economies, encompassing Malaysia, China, India, Indonesia, South Korea, Thailand and the Philippines, the IIF expects them to remain relatively stronger, with a GDP decline of only 0.4% this year, before rebounding to a growth of 8% in 2021.

For Malaysia, in particular, the IIF expects the GDP to shrink 5.5% this year, compared with a growth of 4.3% in 2019. The country is expected to grow of 7.5% in 2021.

Appetite for risk

In terms of capital flows, Malaysian equities saw outflow rising to RM2bil in September from RM1.5bil in the preceding month, while bonds registered slower inflow of RM500mil last month, compared with RM3bil in August.

Year to date, Malaysia registered a total net outflow of RM17.6bil, led by net foreign selling of RM22.4bil in equities, but offset by net foreign buying of RM4.8bil in bonds. This was a reversal from a total net inflow of RM8.7bil in the nine months to September 2019, with the equity market posting an outflow of RM11.2bil, while the bond market attracted RM19.9bil of inflow.

According to Maybank Investment Bank Research (Maybank IB), the trajectory of flows into the country’s bond market should remain positive, especially with the rise in Malaysia’s weight in the Government Bond Index-Emerging Markets Global Diversified Index, unless the outcome of US presidential election causes a significant change in risk sentiment.

FTSE Russell kept Malaysia in its negative watchlist at its recent annual review of its flagship World Government Bond Index (WGBI).

Maybank IB noted while FTSE Russell acknowledged Bank Negara’s initiatives to improve market accessibility for foreign investors, it seemed that more time was needed to assess the efficacies of these measures to maintain the Market Accessibility Level of Malaysia at 2, which is a minimum requirement for the WGBI.

A final decision on Malaysia could come as early as March next year, or latest by September, according to Maybank IB.

Nevertheless, the brokerage says, the risk of Malaysia being downgraded is low, while an additional push for improvements on bond and foreign-exchange liquidity will help increase the chances of the country being retained in WGBI.

This bodes well for the country’s bond market, and should boost investor appetite for its debt papers.

Meanwhile, United Overseas Bank (M) Bhd global economics and markets research notes the divergence between debt and equity flows is expected to persist in the near term as uncertainties linger amid rising Covid-19 infections globally and in Malaysia.

“We expect a volatile period ahead of the US election while the US-China tensions remain elevated.

“However, expectations of broad dollar weakness alongside a robust economic recovery in China should lift Asia foreign exchange, including ringgit, over the next six to 12 months, ” the bank says.

It expects the ringgit to strengthen to 4.05 against the US dollar by the first half of 2021. The local note is currently trading at around 4.15 against the greenback.