What drives capital flows to developing Asia?

What drives capital flows to developing Asia?
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First Published: Tue, Sep 22 2009. 09 55 PM IST

Updated: Tue, Sep 22 2009. 09 55 PM IST
Do fund flows to developing Asia depend on conditions in the developed world or do local factors make a difference? Are the push factors more important than the pull factors? The issue is important, because it will determine the strength of fund flows into the country.
If fund flows are dependent on economic recovery in the West, inflows may be limited, as it is widely expected that the rebound in the developed countries will be shallow. If, on the other hand, inflows are linked to growth in the domestic economy, then it’s probable that we’ll see a lot of foreign money coming in. The Asian Development Bank’s (ADB) recent publication titled Asian Development Outlook 2009 Update considers this question.
The ADB report says that foreign direct investment (FDI) inflows are more resilient to shocks than other forms of capital flows. Portfolio investment and bank loans saw sharper declines than FDI during the current meltdown as well as during the Asian crisis. That’s rather obvious, but the report delves deeper and looks at data on FDI between 1994-2007. It finds that, in terms of attracting FDI flows, while pull factors dominate, push factors too are relevant.
Graphics: Sandeep Bhatnagar / Mint
“In the estimation period, a 1% increase in real income of G3 economies (the US, Japan and the European Union) led to a 1.5% rise in FDI inflows in developing Asia and this relationship held true even during the Asian crisis period,” the report points out.
In India, Reserve Bank of India data show that FDI inflows have remained relatively robust.
For instance, during April-July, direct investment inflows amounted to $10.5 billion (Rs50,610 crore), compared with $12.3 billion in the same period in 2008. In sharp contrast, portfolio flows have been very volatile.
Says the ADB report: “G3 economies’ growth prospects significantly influence movements of portfolio inflows and bank loans. A 1% increase in G3 GDP (gross domestic product) leads to a 5.7% rise in bank loans inflows and a 5.4% increase in portfolio inflows. The relationship is stable before and after the Asian crisis. An increasing number of institutional investors, including insurance companies, pension funds, and hedge funds from the major industrial economies, ensure that the economic prospects of these economies affect portfolio and bank inflows. Of the pull factors, the country’s growth prospects, financial openness, the investment–saving situation, and risks and returns on investment are also important in affecting portfolio investment and bank loans, although the coefficients corresponding to these variables tend to be lower than those for G3 GDP growth prospects.”
But won’t higher growth in some developing countries lead to funds flowing to them? For instance, as the chart shows, ADB has revised downward its forecast of GDP growth this year for the industrial economies while it has revised growth rates upward for India and China.
This column has argued that low growth in the West, combined with loose monetary policy, will lead to liquidity flows to the high-growth economies of Asia. It has happened recently. The ADB study appears to contradict that view.
But elsewhere in the report, the authors point out: “Part of the Asian asset markets’ stronger performance is because the region is recovering faster than other parts of the world. However, the region’s asset price rally is also being fuelled by excess liquidity from the expansionary monetary policies. This overhang is finding its way into equity and property markets.”
At the moment, excess liquidity and the pull factor seems to be determining fund flows.
Write to us marktomarket@livemint.com
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First Published: Tue, Sep 22 2009. 09 55 PM IST