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Capital Flows to BRIC’s Countries. Eduardo Pedreira Collazo BBVA Research Department Capital Flows. Miguel A. Canela Facultat de Matemàtiques Universitat de Barcelona. Javier Santiso Economista Jefe/Director Adjunto Centro de Desarrollo OCDE.

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capital flows to bric s countries

Capital Flows to BRIC’s Countries

Eduardo Pedreira Collazo

BBVA Research Department

Capital Flows

Miguel A. Canela

Facultat de Matemàtiques Universitat de Barcelona

Javier Santiso

Economista Jefe/Director Adjunto

Centro de Desarrollo OCDE

Latin American and Caribbean Economic Association

Mexico - November 2nd, 2006

slide2

I

Introduction

II

Focus on equity flows and preliminary results

III

VAR models: impulse response analysis

IV

Conclusions

introduction
Introduction
  • From a practitioners point of view, we consider extremely important to understand or unveil which factors underly capital flows to emerging markets, in particular equity flows.
      • Arguments are based on: international factors (global) and improvement in local emerging market fundamentals and institutions (pull)
      • More recently, excess liquidity and risk aversion.
      • Evidence regarding global-local factors is far from being conclusive about their relative importance. Very few evidence for liquidity or risk aversion.
introduction global liquidity and low interest rates
Introduction: Global liquidity and low interest rates

Global Interest Rates

vs.

(GDP-PPP weighted)

Stock of Liquidity

(billions)

5.0%

11000

Interest rate

10000

4.0%

Liquidity

9000

3.0%

8000

2.0%

7000

1.0%

6000

0.0%

5000

-1.0%

4000

Mar-04

Mar-05

Mar-98

Mar-99

Mar-00

Mar-01

Mar-02

Mar-03

Mar-95

Mar-96

Mar-97

The sharp decline in interest rates, and global “excess” liquidity has been underlying the surge of private portfolio flows in the last years. Investors' strategies – “search for yield” - deepened this trend, leading to record inflows in 2005 and 2006:1Q.

introduction investors risk appetite
Introduction: Investors' risk appetite

Global Risk Aversion Index Indice - IARG

64 assets: emeging (dollars) and developed (local curencyl)

-6.0

+ aversion

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

- aversion

4.0

dic-02

dic-97

jun-00

jun-05

jun-95

oct-03

oct-98

feb-02

feb-97

abr-01

abr-06

abr-96

ago-04

ago-99

Source: BBVA - Capital Flows.

Investors' appetite for risk is not fixed over time. Besides that, they shift their portfolio allocation according to their expected return and perception of risk.

“Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.” Alan Greenspan

introduction compressed em sovereign spreads
Introduction: : Compressed EM sovereign spreads

US

EMBI+

vs.

Corporate spread BAA

(lhs)

(b.p.)

1800

150

EMBI

BAA-AAA

140

1600

130

1400

120

1200

110

100

1000

90

800

80

600

70

400

60

200

50

Jan-04

Jan-05

Jan-06

Jan-98

Jan-99

Jan-00

Jan-01

Jan-02

Jan-03

Jan-95

Jan-96

Jan-97

Sound macro fundamentals, high commodity prices and global growth, compressed EM spreads to historical levels, below 200 bp.

slide8

I

Introduction

II

Focus on equity flows and preliminary results

III

VAR models: impulse response analysis

IV

Conclusions

focus on equity flows and preliminary results
Focus on equity flows and preliminary results
  • Many researchers studied FDI, bonds or reserves, but much less efforts have been dedicated to explain private equity flows.
      • Many researchers studied FDI, bonds or reserves, but much less efforts have been dedicated to explain private equity flows.
      • We are interested in Private Equity Flows
      • We use equity flows data from EPFR. Data are collected from a universe of 12,000 international, emerging markets and US funds, with more than $5.7 trillions in assets.
      • Investors are worldwide based and not only in US.
focus on equity flows and preliminary results10
Focus on equity flows and preliminary results
  • Correlation: flows, local & global factors
  • A previous exploratory factor analysis, based on principal components, points to a four- factor structure, with DEMBI, DCOMM and MSCIW standing alone, and the other five associated to the remaining factor. This structure accounts for an 85% of the variance.
focus on equity flows and preliminary results11
Focus on equity flows and preliminary results
  • Preliminary regression results
slide12

I

Introduction

II

Focus on equity flows and preliminary results

III

VAR models: impulse response analysis

IV

Conclusions

var cumulative impulse response analysis
VAR: Cumulative impulse response analysis
  • A negative shock in global interest rates is associated with increased cumulative flows in Latin America, whereas for Asia we observe a slight decrease.
var cumulative impulse response analysis14
VAR: Cumulative impulse response analysis
  • Even though the results are mixed, the evidence for Asia gives support for the expected return “chasing hypothesis”.
var cumulative impulse response analysis15
VAR: Cumulative impulse response analysis
  • Panel C give supports to the hypothesis that capital flows are, in part, momentum driven. In the short-run Latin America could suffer a slightly decrease, but in the long--run both regions will be benefited.
var cumulative impulse response analysis16
VAR: Cumulative impulse response analysis
  • The effects of a negative shock in global interest rates in long--run returns is not clear. Panel D suggests that in the short-run these regions will experiment a lower cost of capital, but in the log--run these pressure effects might reverse themselves.
var contemporaneous effects
VAR: Contemporaneous effects
  • The effects of a negative shock in global interest rates in long--run returns is not clear. Panel D suggests that in the short--run these regions will experiment a lower cost of capital, but in the log-run these pressure effects might reverse themselves.
slide18

I

Introduction

II

Focus on equity flows and preliminary results

III

VAR models: impulse response analysis

IV

Conclusions

conclusions
Conclusions
  • Even though local factors have been improving during the last decade, the role of global factors is more important.
    • That is, equity capital can flow into (or out) of a country for reasons other than local fundamentals.
    • Risk appetite can have an important role
  • We found that positive returns shocks are followed by increased short-term equity capital flows, indicating a momentum effect (Bohn and Tesar 1996).
  • A negative shock in global interest rates is associated with increased cumulative flows to Latin America.
  • A negative shock in global interest rates will temporally reduce the cost of capital, but in the long-run this effect is reversed.