Faster U.S. Tightening Won't Threaten Emerging Markets Inflows, QNB Says

Doha, February 24 (QNA) - QNB said Saturday in its weekly nots that the increase in interest rates in the United States will not represent a major threat to capital flows into Emerging Markets (EM) in 2018. The report said that experts have been watching for signs that higher than expected inflation in the U.S. could lead to faster tightening on the part of the fed. An increase in interest rates would in turn bring more investors back to the US in search of higher returns and significantly dent flows to Emerging Markets. The bank believes however that there won't be such a threat as long as EM continues to grow their economies faster than that of the U.S. "Historically there have been two main drivers of EM capital flows (excluding China): interest rates and economic growth. Higher interest rates and growth in EMs, relative to advanced economies, tend to attract capital as they offer higher returns to investors," the bank said in its weekly analysis. QNB notes however that after the global financial crisis, EM capital flows were mainly determined by relative growth rates rather than relative interest rates. Net capital flows to EMs declined in 2010-15, but then recovered in 2016-17. Over the whole period, interest rate differentials between EMs and the US remained broadly stable, even rising as net flows turned negative in 2015. Meanwhile, EM growth differentials have moved in line with capital flows. As the growth differential declined in 2010-15, net flows to EMs also fell, this then reversed in 2016-17. The report adds that the finding has been widely corroborated by the economic research literature on EM capital flows. Estimates reveal that EM capital flows have become more than 1.5 times more responsive to relative growth than relative interest rates over the past two years. Moreover, the impact of a change in relative interest rates on capital inflows has diminished by around 13% compared to the pre-crisis period of 2005 to 2008 whereas the capital flow sensitivity to relative growth has remained about the same. "While less important that relative growth rates, interest rate differentials between EMs and the US have still been supportive of capital flows to EMs. Central banks in both advanced and EM economies cut rates to historical lows in the wake of the financial crisis and rates were kept low until 2015 when the US began to normalise policy." EM central banks have been hiking rates since 2015 for a variety of reasons. Some were responding to the Fed while others were trying to support their currencies and militate against capital outflows as a result of commodity price shocks, political risks or other external pressures. As a result, the interest rate differential relative to the US remained generally stable over the post-crisis period, maintaining the attractiveness of EM interest-bearing assets to foreign investors. Coupled with faster growth in the U.S., QNB maintains that Emerging Markets will not be threatened by faster-than-expected tightening by the Fed. (QNA)