Although inflows to emerging markets (EM) have been easing in recent weeks, we think that there is potential for a further rise in inflows as investors still favour EM assets, encouraged by cyclical and structural factors. The Institute of International Finance expects higher net private inflows to EM (US$960bn in 2011 and over US$1.0tr in 2012 compared to US$908bn in 2010). Another swing factor influencing capital flows is investors’ risk perception of EM assets, which is sensitive to a change in sentiment or policy risk. There are two risks that could reverse the capital flows (i) the boom-bust asset price cycle if monetary and credit tightening is not quick or strong enough to prevent overheating, and (ii) a withdrawal of the G3’s monetary stimulus. We believe strong economic and financial conditions in EM could provide a buffer to accommodate as well as mitigate the large shifts in funds.
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