Capital Flows to BRIC’s Countries

Miguel A. Canela Eduardo Pedreira Collazo Javier Santiso

Facultat de Matemàtiques BBVA Research Economista Jefe/Director Adjunto
Universitat de Barcelona Department Centro de Desarrollo OCDE
Capital Flows

Latin American and Caribbean Economic

Association
Mexico - November 2nd, 2006
I Introduction

II Focus on equity flows and preliminary results

III VAR models: impulse response analysis

IV Conclusions

2
 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.

3
 Introduction: Global liquidity and low interest
rates

Global Interest Rates

(GDP-PPP weighted)vs.
Stock of Liquidity(billions)
5.0% 11000
The sharp decline in interest rates,
4.0%
Interest rate 10000 and global “excess” liquidity has
Liquidity been underlying the surge of
9000
3.0% private portfolio flows in the last
8000 years. Investors' strategies –
2.0% “search for yield” - deepened this
7000 trend, leading to record inflows in
1.0%
6000 2005 and 2006:1Q.
0.0% 5000

-1.0% 4000
Mar-98

Mar-99

Mar-00

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05
Mar-95

Mar-96

Mar-97

4
 Introduction: Investors' risk appetite

Global Risk Aversion Index Indice - IARG

64 assets: emeging (dollars) and developed (local curencyl)
-6.0
-5.0
+ aversion Investors' appetite for risk is
-4.0 not fixed over time. Besides
-3.0
that, they shift their portfolio
-2.0
-1.0
allocation according to their
0.0 expected return and
1.0 perception of risk.
2.0
3.0 - aversion
4.0
dic-02
dic-97

jun-00

jun-05
jun-95

oct-03
oct-98

feb-02

ago-04
feb-97

abr-01

abr-06
ago-99
abr-96

Source: BBVA - Capital Flows.

“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

5
Introduction: In general, improved
fundamentals

6
 Introduction: : Compressed EM sovereign
spreads

EMBI+ (lhs) vs. US

Corporate spread BAA
(b.p.)

1800 150
EMBI BAA-AAA
1600 140
130
1400 Sound macro fundamentals, high
120
1200 commodity prices and global
110
growth, compressed EM spreads
1000 100
to historical levels, below 200
90
800 bp.
80
600
70
400 60
200 50
Jan-03

Jan-04

Jan-05

Jan-06
Jan-98

Jan-99

Jan-00

Jan-01

Jan-02
Jan-95

Jan-96

Jan-97

7
I Introduction

II Focus on equity flows and preliminary results

III VAR models: impulse response analysis

IV Conclusions

8
 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.

9
 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.

10
 Focus on equity flows and preliminary results
 Preliminary regression results

11
I Introduction

II Focus on equity flows and preliminary results

III VAR models: impulse response analysis

IV Conclusions

12
 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.

13
 VAR: Cumulative impulse response
analysis

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

14
 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.

15
 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.
16
 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.

17
I Introduction

II Focus on equity flows and preliminary results

III VAR models: impulse response analysis

IV Conclusions

18
 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.

19