One door closes, another one opens. Capital beating a retreat from Europe, land of austerity and heightened sovereign risk, is charging into emerging markets. The Washington-based Institute of International Finance reckons net private inflows to emerging markets will exceed $700bn this year – up from $530bn last year – and rise a further $40bn or so in 2011.
That money should chase superior yields is logical. There is also a pleasing symmetry. Asian sweat and frugality helped pay for Americans' spending spree; now western loose monetary policy is helping fund Asian roads and balance sheets. Alas not all money is equally productive. Volatile “hot money” flows, aimed at making a fast buck, are also on the rise as foreigners pile into fast-growing economies. Spooked authorities in the likes of Brazil, South Korea and Indonesia have responded by imposing capital controls. China, counter-intuitively, has moved in the opposite direction by ostensibly removing the renminbi's peg to the dollar: at face value, that encourages short-term punting. But this is less daring than it appears. Beijing retains the levers of control, not least over the level of appreciation, and its deflating real estate and equities markets do not entice in any case.
Indeed, perhaps the real fear for emerging markets is that the money starts to abate. Western banks' ability to provide financing is clearly constrained. Foreign direct investment, the most welcome of funding for emerging economies, is likely to be well below the 2007-08 boom years. Narrowing interest rate differentials as tightening begins in the western world will erode gains from emerging market bonds, while some stock markets are ludicrously over-priced: Indonesia's is on 29 times last year's earnings. And no country knows better how fickle foreign money can be. When the currency was in meltdown and the International Monetary Fund was on call, foreigners fled. Today, 13 years later, they own one-quarter of outstanding local currency government bonds.