Foreign institutional investment inflows have increased in the recent past and the benchmark Sensex has perked up. Is a bull market round the corner? If an International Monetary Fund (IMF) working paper—Capital Flows are Fickle: Anytime, Anywhere by John Bluedorn, Rupa Duttagupta, Jaime Guajardo and Petia Topalova—is an indication, it may be too early to celebrate.
According to the paper, net flows to emerging markets are strongest when global interest rates and risk aversion are both low, as the chart shows. That’s what worked in favour of emerging markets, including India, in the last few years. But that benign scenario now appears set to change, with the US looking to raise interest rates.
The IMF paper also says, “Despite differences in policies across economies and over time, the typical economy has tended to experience relatively high volatility and low persistence of capital flows.” That suggests it’s the “push” factors that determine capital flows to emerging markets, rather than “pull” factors in the shape of domestic policies in emerging market economies.
True, net capital inflows tend to be the highest when, along with lower global interest rates and low risk aversion, growth differentials between the emerging markets and advanced economies are high. But the paper also says that “net flows are mildly pro-cyclical with domestic GDP (gross domestic product) growth”. While growth is a positive, it is only mildly so.