Investors pull back from emerging market stocks and bonds in June

Mounting risks of a global recession, geopolitical tensions and high inflation are hurting outlook, says IIF

China's equities market recorded foreign inflows of $9.1 billion in June. Reuters

Emerging market stocks and bonds recorded an outflow of $4 billion in June, marking the fourth consecutive month of outflows, amid mounting concerns about a global recession and inflation, the Institute of International Finance said in its latest report.

Outflows stood at $4.9bn in May, $4bn in April and $9.8bn in March, compared with inflows of $17.6bn and about $1.1bn in February and January, respectively.

Regionally, gains were only registered in Latin America, which recorded inflows of $5.7bn, with all other regions showing outflows.

“Mounting global recession risk is weighing on EM flows as anxiety builds over geopolitical events, tighter monetary conditions and realised inflation. The continued volatility in equity markets has hurt the outlook considerably,” the IIF said.

Fears of a recession have been steadily increasing amid rising inflationary pressures, steep interest rate increases by central banks and the Ukraine war.

Surging oil and gas prices, exacerbated by Russia’s war in Ukraine, have fed into already rising inflation.

For 2022, inflation has been forecast at 5.7 per cent in advanced economies and 8.7 per cent in emerging market and developing economies, according to the International Monetary Fund.

Last week, the IIF warned that the risk of a global recession is “rising sharply” amid a combination of “shocks”, including the impact of the Russia-Ukraine conflict on the eurozone, Covid-19 pandemic-related uncertainty in China and the sharp tightening in US financial conditions.

The global economy is projected to grow 2.3 per cent in 2022, compared with an earlier 4.6 per cent estimate, the IIF said in a May 26 report.

The World Bank slashed its growth forecast for the global economy for the second time this year as a result of the Ukraine war, lowering its estimate for 2022 to 2.9 per cent from the 3.2 per cent projection it issued in April, and the 4.1 per cent estimate made in January.

The IMF also cut its growth forecast for the global economy to 3.6 per cent in 2022 and 2023.

“We are in a global interest rate and high inflation shock. Longer-dated government bond yields have risen sharply across advanced economies, tightening financial conditions, weighing on growth, and pushing up risk aversion,” the IIF said.

“This mechanism is weighing on flows to emerging markets. We see that the current outflow episode is similar in scale to the RMB [Chinese yuan] devaluation scare in 2015 and 2016.”

The IIF also found that foreign investors poured more capital into China's equities but cut back on holdings in its bonds, an opposite trend to other emerging markets.

China's equities market recorded foreign inflows of $9.1bn, while emerging markets equities showed outflows of $19.6bn, the IIF data tracker showed.

Meanwhile, China's debt market registered $2.5bn of outflows last month, while emerging markets received inflows of $9.1bn, aided mainly by resilient interest in corporate bonds.

The Chinese government's implementation of a strict “zero-Covid” policy to keep the virus at bay has dealt the economy a severe blow, with major cities like Shanghai locked down for weeks and restrictions in many other places cutting into spending, shutting factories and blocking supply chains.

People queueing for a Covid-19 test in Beijing. EPA

“For the coming months, several factors will influence flow dynamics, among these the timing of inflation peaking and the outlook for the Chinese economy will be in focus,” the IIF said.

“Despite the recent readings, we remain constructive, as most of the big emerging markets started hiking [interest rates] well before advanced economies, which now leaves real longer-term interest rates across many EMs well above their G10 counterparts,” it said.

That provides some protection from the current global interest rate shock, it added.

However, there are “obviously pockets of weakness in EM” — where real interest rates are deeply negative — and risks for these countries are growing quickly, the IIF said.