The EM competition for capital

The Chinese economy is attracting more foreign capital due to structural changes and its belated entry into major bond and equity indices. These shifts could have significant implications for other emerging markets.

 For thousands of years, Chinese citizens hailed the dynastic Emperor as the ruler of Tianxia, or ‘all the lands below heaven’. China was Zhongguo, the ‘middle kingdom’ – literally the centre of the planet.

In modern finance, China has been just as central to the worldview of emerging market investors. After its entry into the World Trade Organisation in 2001, China’s rapid development and growing appetite for resources boosted other emerging economies. Exports from low- and middle-income nations to China rose by a factor of 12 between 1995 and 2010, compared with a twofold increase in their exports to everywhere else.¹

Despite its transformation into a trading and manufacturing powerhouse, however, China has not traditionally attracted foreign capital flows commensurate with its vast size. Restrictions on foreign investment, coupled with inefficient domestic markets, deterred international investors. But this could be about to change, with big implications for capital flows across emerging markets.

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Two key drivers are leading China to hoover up more overseas capital. The first is its declining current account surplus, which reflects structural shifts in the Chinese economy. Morgan Stanley analysts forecast China will run a deficit this year, for the first time since 1993.²The government is loosening the rules over foreign investment as it seeks to plug the gap.

The second driver is China’s inclusion in several global market indices. The weighting of Chinese A-shares in the MSCI EM equities index is rising and China is also on the brink of joining major fixed income benchmarks, potentially sparking outflows from other index constituents. The combined effect of these developments is likely to be increased competition for capital among smaller emerging economies dependent on foreign financing.

“There are legitimate worries about the shifting tide of global capital towards China and whether this will mean a falling supply of capital for other emerging markets, exposing them to tighter financial conditions and lower growth rates over time,” says Maulshree Saroliya, macro strategist at Aviva Investors in London.

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References

‘Winners and losers from China’s commodities for manufactures trade boom,’ VOX EU, September 2017.