Capital flight scenario for RGMs
A generalized flight from risk could do damage across rapid-growth markets (RGMs) and their partners.
To assess the impact of this risk, we have used Oxford Economics’ Global Model to highlight a capital flight scenario for RGMs. In this scenario, the Fed changes its forward guidance to a less dovish tone, following the Federal Open Market Committee meeting that will take place in March.
This prompts investors to price in a rise in interest rates earlier than expected. This triggers a wave of risk aversion, leading to changes in portfolio allocations away from RGMs’ assets.
Since the Asian crisis of the late 1990s, most rapid-growth economies have reduced their external imbalances by accumulating more foreign exchange reserves and reducing the share of US dollar-denominated bonds in overall government debt. Such measures have made these markets more resilient to abrupt changes in external financing, relative to how they were in 1997.
Brazil, the Philippines, Malaysia and Thailand have much higher reserves as a proportion of their short-term debt than they did before the Asian crisis. In addition, some countries such as China and Brazil have been relatively successful at attracting more stable FDI flows.
In our scenario, GDP growth in RGMs slows sharply in 2014-15 because of:
- Capital flight
- High inflation and interest rates
- Higher debt payments
- Falls in share and house prices
- Lower potential growth
Turkey and India would see the largest impact on their growth rates, because of sizeable capital flight and a sharp contraction in business confidence. Growth in India could slow to less than 3% over the next couple of years, before picking up to around 5% in 2016–17.
Brazil would see large effects through the impact on domestic demand of higher inflation and interest rates. In addition, slower world growth would see oil and commodity prices drop. This would lower Brazil’s export earnings and, as a result, growth could grind almost to a halt next year.
Countries such as Qatar and Saudi Arabia, that have large current account surpluses, would be better insulated from capital flight. However, lower oil prices would affect their export earnings.
Growth in China could slow to around 4% in 2015 as following the effects of a sharp correction in property prices. In addition, the stress would likely trigger the need for the Government to recapitalize some smaller banks in China. While it has resources to do this, it would lead to a sharp slowing in credit growth for investment.
In this scenario, GDP growth in RGMs falls to 3.7% and 2.8% in 2014 and 2015 respectively, compared with 4.7% and 5.1% in the baseline.
As RGMs falter, growth in advanced economies also decelerates due to weaker external demand and increased volatility in financial markets.
For instance, US GDP growth decreases to 2.6% and 1.7% in 2014 and 2015 respectively, compared with 3.1% and 3.2% in the baseline.
World GDP growth falls to 2.4% and 1.8% in 2014 and 2015 respectively.
This is quite a severe scenario, but it illustrates the potential effects of capital flight on RGMs.