Emerging countries facing massive cash outflow : Reality against the Theory !


Emerging countries facing massive cash outflow : Reality against the Theory !

Emerging countries are experiencing  some turbulences in  theirs capital transfers ! Once a popular destination for foreign direct investment , these countries are becoming places to avoid. Why did they get into that mess? To understand the cause of the excessive outflow of capital from emerging countries, it is necessary to analyze the factors that determine the massive inflow of capital in these countries!

Capital flows depend on the theory of three factors

1. The difference in economic growth : economic growth is the primary factor to  open investors and speculators eyes! In almost 100% of cases, all countries that have experienced massive capital inflows first attracted attention with their impressive economic growth rates . China, India and Mozambique are examples among many others .
2. The difference between domestic interest rates and the overall interest rate ( often dictated by the interest rate of the U.S. central bank -FED ) . When rates the Fed are very low, speculators prefer to allocate their funds to regions or rates are high.
The appetite for financial risk. It is directly linked to the differential in interest rates .
image. There is an inverse relationship between market volatility index (VIX) and capital inflows to emerging countries . The more financial markets in advanced economies are unstable, the more emerging countries will experience a strong capital inflows.

3. Capital control policy. A control of capital inflow capital tends to discourage speculators.
From these four points, the outflow of capital would take place due to:

a. Weak economic growth in emerging countries ! is it proven?
b. A reduction in the anticipated differential in interest rates ( Dti *) . The Fed plans to raise interest rates (fed (i ) *) , this will reduce the differential in interest rates .
Dti * = em (i ) -fed (i ) * system em( i) = interest rate in emerging countries .

A reduction in the differential will be followed by an outflow of capital from emerging countries. Is it proven?

Control sources of rigidity capital transfers capital is also the cause of the excessive outflow ! Is it proven?

Emerging countries and the new dynamic of international transfers of capital.


The current situation of the transfer of capital between the different financial markets is a suitable case study for students in economics. To understand what is happening, it is necessary that I recall on the role of interest rates in capital transfers.

Mundel and Fleming are two economists who have developed this theory. According to them “speculators” are looking for investments with high yields. When interest rates on the domestic markets are above the average of international rates, foreign investors are motivated to invest in the domestic market. It’s normal they want to take advantage of the high return. On the domestic market however, investors facing high interest rates, national do not have the incentive to invest because the cost of borrowing becomes expensive. On the other side people with solid savings rejoice for with high interest, their savings rates grow.

Application: the European Central Bank decided to maintain as long as possible lower interest rates. European investors welcomed this decision which will reinvigorate investment. In Germany, however people, with strong savings do not see this policy with the good eyes, because low interest rates diminish the value of their savings. It is the same thing in the US where the FED has decided to inject into the U.S. economy of money! According to the theory, this practice should lower interest rates and therefore lead to the same results as Europe. American savers are losers while U.S. investors are the winners.

Now let’s look at the other side of the equation with the eyes of speculators!

When domestic interest rates are low, they prefer to transfer financial assets into markets that have high interest rates in order to take advantage of the increase in these rates!

Application: During the 1991 recession, the US in order to create economic growth, lowered interest rates to give a “boost” to overall demand (investment and consumption). Because of this monetary policy, investors (speculators) took their money from the financial market to Latin America where interest rates were not as high but much more attractive for long term profit in fall of a strong economic growth. Between 1991 and 1992 Latin America has experienced a 42.5% increase influx of foreign capital.

What is happening today is not something new!

Economics is a science which repeats itself without anyone to notice it.Early 2009, the economic and financial crisis is in full swing! The FED reduced interest rates in order to bounce the aggregate demand; the Europeans are as much as to zero. Consequences: investors looking for high return on their investments deserted the American and European markets. This time, the direction is not America a group of emerging countries known as the BRICS ‘Brazil-Russia-India-China-South Africa ‘.  The honeymoon lasted nearly five years. During this period, trillions of dollars and Euros will rain on the economies of these countries and other frontiers markets. To avoid the excessive entry of currency to be source of inflation, central banks in these countries have even for a time adopted a tight monetary policy through  taxation of international capital movement.

This situation is now changing since Europe has managed to save its currency!  Greece and the “others” are still members of the euro. In the land of our cousin Obama, economic growth is on his way. The index of industrial production is rising since the beginning of this year. Suddenly the FED does not see any reason to maintain low interest rates, which has been the case since 2008.

May 2013, Bernake announced his intention to stop injecting fresh money into the U.S. economy. It means indirectly that the interest rates on U.S. markets are going soon to increase! Good I mark a break! If you have followed me, then can you tell me where speculators will rush? Not in Latin America please!  Earlier as I said it, investor will rush to markets with high “short term” interest rate. This means in the US economy or at worst in the EU land. Now I hope you understand what motivates speculators!

Since the Bernake announcement, emerging countries have experienced an extensive capital outflow.  A US Think-than recorded a consecutive fifteen months of capital outflow from emerging countries.Brazilian President Russeff even called unjust, what is happening! The mere announcement and not even the implementation of this decision is enough to disrupt the financial markets of the BRICS.

How should the emerging countries react?

Should they establish restrictions on the capital movement? In June of this year, Brazil has removed its 6% tax on capital transfer and still not managed to stop the bleeding! Should emerging countries raise interest rates to attract again investors? This is dangerous if the rise in interest rates has nothing to do with the fundamentals of the economy!

I think the decision of the Fed should not create a wind of panic on the financial markets of emerging markets countries. The Fed may decide at any time to stop the expansionary monetary policy, investors will not rush everything back in U.S. markets! They will wait and have a clear vision of the U.S. economy (the consolidation of public debt, a still high unemployment).The emerging countries should continue to put their public finances in order in order by reducing their large budget deficits. this applies to South-Africa, Brazil, Turkey and Indonesia.

Francis Konan

** Picture from blog.fieldoo.com