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Prospects Weekly: Private capital flows to developing countries eased in October

Global Macroeconomics Team's picture
Private capital flows to developing countries eased in October, but remain close to their highest level in more than a year, led by robust bond issuance by emerging market sovereigns and firms. Business sentiment has strengthened in some countries, including the US and several emerging markets, but remains weak in general amid US “fiscal cliff” and Euro Area risks. In the US, new discoveries and innovations have pushed down domestic prices of natural gas, creating arbitrage opportunities between domestic and international markets.
Private capital flows to developing countries remain high, despite easing in October. Gross international capital flows to developing countries equaled $49 billion in October, the second highest inflow over the past 15 months, but down from the record $71bn of inflows during September. Euro Area debt turmoil in May caused capital flows to slow, but stabilization of financial market tensions and high-income monetary policy prompted the recent uptick in flows. Bond issuance was particularly strong at $32 billion in October, with 44% of the total destined for the financial sector. Notable issues included a $2 billion bond sale by Russia’s Sberbank, a $1.5 billion offering of 10-year sovereign bonds by Chile, and a $500 million sale by Bolivia (its first in nearly a century). New equity issuance and bank lending (especially to Emerging Europe and Latin America) moderated, partly because low bond yields made bonds a more attractive option for some borrowers.

 

Business sentiment indicators have strengthened in several countries, but remain weak in general amid risks to the global economy. Manufacturing Purchasing Managers’ Indexes (PMIs) for October suggest a strengthening of activity in the US as labor and housing markets continue to improve. PMIs also gained ground and suggest expansion in Brazil, Indonesia, India, Russia, and Turkey. In China, however, both the official and Markit PMI are below or close to the no-growth 50 threshold despite recent accelerations in industrial activity. Similarly, the manufacturing PMI for both core and periphery Euro Area countries points strongly toward further contraction, despite a stabilization and even small gains in industrial activity during recent months. Business pessimism may be reflecting market worries that the U.S. fiscal cliff or Euro Area tensions could flare up dampening demand and prospects—a view seemingly supported by weak sales of capital goods.

 

The wide gap between U.S. natural gas prices and European natural gas and crude oil prices suggests downside risks on oil prices. The post-2005 increase in crude oil prices induced innovation in both natural gas and oil extraction technologies such as horizontal drilling and hydraulic fracturing. A 28 percent increase in U.S. natural gas production between 2005 and 2011 has depressed domestic prices. Low prices have induced electrical and petro-chemical producers to substitute natural gas for coal, but a similar shift by the transportation industry has yet to take place, in part due to the absence of distribution networks and safety concerns. So far, export licensing requirements have prevented U.S. producers from selling into world markets where natural gas prices are much higher. U.S. natural gas costs only 29 and 20 percent as much as European and Japanese gas. Should licenses become more readily available, the arrival of US gas on international markets could exert significant downward pressures on international prices of both natural gas and crude oil.

 

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