Spillover effects of a Trump win could hit emerging markets: IIF

Tokyo

THE Institute of International Finance (IIF) said on Thursday that a Trump presidency could have a significant spillover impact on emerging-market economies and on advanced economies through investments and exchange rates.

"Uncertainty will persist at least until the election is over," it said in a report, on a day the US dollar retreated significantly in value against other leading currencies.

Renewed uncertainty triggered by the expected closeness of the race to the White House comes at a time when portfolio investment flows to emerging markets - especially China and Russia - have been recovering, although they eased recently on expectations of a US Federal Reserve rate hike, said the Washington-based body.

The IIF represents some 500 leading banks and other financial institutions worldwide, so the concerns expressed in its report on global capital flows reflects the inputs of many of these institutions.

Their concerns centre on the impact that a Donald Trump presidency could have for the US and, more broadly, the global economy.

The IIF is taking a Hillary Clinton victory as the "baseline scanario" for its forecasts; a Trump victory could change the picture drastically, it said.

"For emerging-market investors, the Mexican peso has been the most visible transmission channel of 'Trump risk' to emerging markets," it said.

And Mr Trump's stated intent to keep US investments at home suggests that US direct investment to Mexico and other emerging markets could be curtailed.

Capital flows to emerging markets should continue to improve gradually next year, the IIF suggested. Charles Collyns, the institute's managing director and chief economist, said: "After some turbulence earlier this year, we expect the current revival to continue into 2017.

"Markets have been generally buoyant since the Brexit vote, and greater stability in China and a pickup in activity more broadly have also helped. Provided these trends continue, we expect 2017 to be better - but not great."

The IIF projects private non-resident capital inflows into the 25 emerging-market economies it covers to reach US$769 billion next year - up from US$640 billion this year. The US$769 billion comprises US$441 billion in direct investments plus US$101 billion in portfolio investment (stocks and bonds mainly) and US$227 billion in private credits from banks and others.

The IIF said it has marked up these estimates as result of "upward revisions to portfolio debt and other inflow components in China and Russia".

Hung Tran, the IIF's executive managing director, named the strong shift in market expectations for the Fed's policy-rate trajectory and the loss of confidence in renminbi stability in China as being among the biggest risks to the institute's outlook.

"Global political risks are also potential clouds on the horizon as the backlash to globalisation in mature economies increases," he added.

The IIF said the US Federal Reserve is likely to continue on a gradual trajectory for rate normalisation, and that it expects the Fed to raise the Fed funds rate in December and twice in 2017; it added that three rate hikes before the end of next year would be "significantly more than the market has priced in".

A "hunt for yield" will continue to drive portfolio capital investment into emerging markets, although not to the extent that has done in the earlier part of this year, it suggested.

"This year's sharp run-up in global equity prices - coupled with cautious outlook for earnings - has left valuations at significantly higher levels across both mature and emerging markets.

"For mature markets, forward price-to-earnings ratios are close to their highest levels since 2002, when they were over 20 times, driven mainly by the US."

Meanwhile, emerging-market valuations are back to 2010 levels - a period when emerging-market real GDP growth was running at 6 to 7 per cent, or significantly faster than the current rate, the report noted.

Emerging markets in East Asia are expected to see the largest improvement in capital inflows next year, the report said. "Non-resident private capital inflows are projected to climb more than US$70 billion to US$348 billion, driven by China (US$40 billion) and India (US$32 billion)." This includes direct and portfolio investment. China's policymakers are expected to continue to do what is needed to avoid volatility in the run-up to an important political transition in 2017."

The report added that strong growth and increased commitment to reforms has positioned India as a standout in the region.