International capital flows: Final picture from 2009

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As snow covers ground in Washington, D.C., debt markets swoon, and another year comes to a close, it seems like a good time to look at what actually happened to international capital flows to developing countries last year and what that might portend for flows in 2010, as this year’s numbers will be finalized in coming months.

At a time when the global economy has seen the most severe slowdown since the end of WWII, capital flows to the developing world—including private flows (debt and equity) and official capital flows (loans and grants from all sources)—are in an overall slump, well below their level in 2007 ($1.1 trillion). According to the just-published Global Development Finance: External Debt of Developing Countries, which contains detailed data on the external debt of 128 developing countries for 2009, net capital flows to these countries fell by 20 percent from $744 billion in 2008 to $598 billion in 2009. 

Debt-related flows to developing countries plummeted in 2009, falling by 35 percent to $136 billion ($210 billion in 2008 and $467 billion in 2007), while the ratio of external debt stocks to exports rose to 74.6 percent, its highest level since 2005. But there were some bright spots—against expectations bond issuance by developing countries rose to $51 billion in 2009, up from $24 billion in 2008. And developing countries received extraordinary contributions from official creditors, including the World Bank Group, to help them cope with the 2008 crisis and continued challenges in 2009.

Some of the big emerging market countries weathered the market turbulence thanks to lower returns in high-income countries, which sent hot money looking for higher yields in the emerging economies. As the GDF reports, in 2009 net portfolio equity inflows jumped sharply to more than $108 billion from a net outflow of $53 billion in 2008.  But, the vast majority of these flows went (unsurprisingly) to the biggest emerging markets, including Brazil, China, India, and South Africa.

Looking beyond the aggregate reveals some important regional trends. Countries in Europe and Central Asia (ECA) bore the brunt of the downturn and saw debt and equity flows plunge 66 percent to $90 billion, despite a 300 percent rise in net inflows from official creditors and large scale rescue packages for some countries in the region. Furthermore, the precipitous fall in net medium-term bank lending to emerging economies in ECA, down to $7 billion ($105 billion in 2008) in the wake of mounting concerns about nonperforming loans and large domestic adjustments, should be closely watched. Some economists continue to worry about certain low- and middle-income countries in ECA because market volatility as well as fiscal pressures may yet spill over from other countries in Europe.

Other regions, however, reported increased net capital flows in 2009. South Asia, for example, saw net capital inflows rise 28 percent, driven by the $37 billion turnaround in portfolio equity flows to India. In Sub-Saharan Africa, net flows were up 16 percent due to resurgence in portfolio equity flows (mostly to South Africa) and a doubling of inflows from official creditors. 

Preliminary reports for 2010 indicate that capital flows to core emerging market countries (Brazil, Chile, China, Colombia, Egypt, Indonesia, Malaysia, Mexico, Panama, Peru, Philippines, Thailand, and Turkey) remain strong, particularly in East Asia and Pacific.

The sharp increase in net inflows from international financial institutions (IFIs) in 2009 stands out.  They provided record amounts of assistance to help developing economies cope with the strains of the crisis. Overall net capital inflows (loans and grants) from official creditors rose 50 percent to $171 billion in 2009, driven by a sharp rise in loan disbursements by the IFIs.  The World Bank (IBRD and IDA combined) was the most important of these creditors, providing $31 billion (31 percent of total IFI disbursements on a net basis). This represents a 50 percent increase over the net amount disbursed in 2008 and the highest in the history of the institution.

One of the key challenges facing policymakers in emerging economies is to balance the interests of foreign capital with domestic economic priorities. Many countries are taking a more nuanced view regarding the role of short-term foreign capital, because they recognize such inflows  may give rise to asset bubbles. Copious flows from foreign institutional investors in particular have prompted various capital control measures by Brazil, Indonesia, and other countries.

No economy wants a stampede of hot money driven by a herd mentality rather than by rational analysis of market prospects, since such flows can flee emerging markets just as fast as they flood in.  With this in mind, it is increasingly important to study external factors that influence investor sentiment—often the decisions to invest en masse in an emerging market economy have far more to do with the enthusiasms of investors in, say, London, New York, or Tokyo, than in Delhi, Jakarta, or Rio.

Fortunately one can get a handle on many of these knotty issues thanks to the comprehensive and detailed information on debt flows reported to the World Bank’s Debtor Reporting System (DRS). Now in its 60th year of continuous operation, it is the Bank’s oldest statistical system and the leading international source for information on the external debt of developing countries.

The 2011 GDF is a continuation of the World Bank’s publication, Global Development Finance, Volume II (1997 through 2009) and its precursor, World Debt Tables (1973 through 1996). To access the latest report, please visit our Open Data site here. To access the DRS database directly, click here.