Capital Flows to BRIC

1
Capital Flows to BRICs Countries

• Eduardo Pedreira Collazo
• BBVA Research Department
• Capital Flows

Javier Santiso Economista Jefe/Director
Adjunto Centro de Desarrollo OCDE
Miguel A. Canela Facultat de Matemàtiques
Universitat de Barcelona
Latin American and Caribbean Economic
Association Mexico - November 2nd, 2006
2
Introduction
I
Focus on equity flows and preliminary results
II
VAR models impulse response analysis
III
Conclusions
IV
3
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.

4
Introduction Global liquidity and low interest
rates

• 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 20061Q.

5
Introduction Investors' risk appetite

• 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
6
Introduction In general, improved fundamentals
7
Introduction Compressed EM sovereign spreads

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

8
Introduction
I
Focus on equity flows and preliminary results
II
VAR models impulse response analysis
III
Conclusions
IV
9
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.

10
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.

11
Focus on equity flows and preliminary results

• Preliminary regression results

12
Introduction
I
Focus on equity flows and preliminary results
II
VAR models impulse response analysis
III
Conclusions
IV
13
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.

14
VAR Cumulative impulse response analysis

• Even though the results are mixed, the evidence
  for Asia gives support for the expected return
  chasing hypothesis.

15
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.

16
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.

17
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.

18
Introduction
I
Focus on equity flows and preliminary results
II
VAR models impulse response analysis
III
Conclusions
IV
19
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.