Capital Flows to Emerging Market Economies

The Institute of International Finance, Inc.

Capital Flows to Emerging Market Economies
Page 1
September 24, 2005

Capital Flows to Emerging Market Economies
© 2005. The Institute of International Finance, Inc. All rights reserved. The contents of this report may be neither reproduced nor distributed in whole or in
part outside the membership without the prior written approval of the Institute of International Finance, Inc.

September 24, 2005

Overview

The strong recovery in net private capital flows to emerging
markets that began in 2003 has continued this year. Although a
moderation in the pace of flows is anticipated in the next several
quarters, the overall level envisaged for 2006 remains relatively
elevated. Downside risks have increased, however, in the face of
rising concerns and unease about a potentially less hospitable
global economic environment going forward.

Private flows are projected to reach a record high
$345 billion this year before slowing to $318 billion in 2006
(Table 1, Chart 1). This year’s expected flows surpass the
previous record of $323 billion reached in 1996 prior to the
Asian crisis. The continued robustness in flows is being supported
by a further pickup in direct investment and a record pace of bond
issuance as sovereign and private borrowers endeavor to stay ahead
of the curve before the tightening policy interest rate cycle starts to
hit bond markets visibly. With many debtors having already taken

the opportunity to pre-finance obligations due in 2006, the current
pace of bond issuance is unlikely to be sustained next year,
contributing to an overall slowdown in private capital flows to
emerging markets. This forecasted slowdown could become more
pronounced if downside risks from a further jump in oil prices,
unanticipated policy slippage or other problems in a major emerging
market economy, or a sudden shift in investor risk aversion
stemming, inter alia, from concerns over global imbalances or the
fragility of global growth were to materialize.

The strong private capital flows to emerging markets in
2005 has occurred against a backdrop of strong global economic
expansion, which has been supported by strong corporate
profitability and buoyant housing markets in the United States
and elsewhere. The measured but sustained monetary tightening in
the United States has yet to dampen growth, as bond yields have
tended to drift down. Neither have sharply higher oil prices begun
to visibly affect the forward momentum of global activity, although
this could now change in the aftermath of Hurricane Katrina.

Low yields on U.S. Treasury bonds and a flat yield curve
have pushed investors to purchase lower rated credits,
compressing credit spreads, including those on emerging market
bonds. Despite the historically high price of emerging market
assets, investor demand remains strong, reflecting both the
search for yield and the improving fundamentals in many key
countries. Most of these countries have experienced robust growth
with relatively little inflation while accumulating substantial
international reserves as a result of current account surpluses and
large capital inflows. Growing confidence on the part of investors

in the policy performance of some of the key emerging market
Table 1
Emerging Market Economies' External Financing
(billions of U.S. dollars)
2003 2004 2005f 2006f
Current account balance 118.0
151.9 194.4 180.7
External financing, net:
Private flows, net 213.7
317.4 345.2 317.8
Equity investment, net 128.9 167.5 191.3 184.4
Direct investment, net 95.9 132.2 148.9 145.8
Portfolio investment, net 33.0 35.3 42.3 38.7
Private creditors, net 84.8 149.8 153.9 133.3
Commercial banks, net 25.4 61.1 63.5 57.8
Nonbanks, net 59.4 88.7 90.4 75.5
Official flows, net -21.4
-30.6 -50.4 -24.2
IFIs -6.6 -16.4 -23.9 -12.4
Bilateral creditors -14.8 -14.2 -26.5 -11.8
Resident lending/other, net
1
-37.6 -38.6 -87.7 -72.3
Reserves (- = increase) -272.6 -400.0 -401.4 -402.0
f = IIF forecast
1
Including net lending, monetary gold, and errors and omissions.
Chart 1: Capital Flows to Emerging Markets
(billions of U.S. dollars)
-100

0
100
200
300
400
94 95 96 97 98 99 00 01 02 03 04 05f 06f
Official lending Private equity Private credit
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Capital Flows to Emerging Market Economies
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September 24, 2005

countries has contributed to both direct and portfolio investment
inflows as well as bond flows.

Although the general conditions in emerging markets as a
whole remain broadly conducive to growth and stability, less
favorable economic performance and troublesome
developments, including the persistence of high debt ratios and
a tendency to hold back on structural reforms, have been
observed in some countries. These problems could be exacerbated
by a possible deterioration in global macroeconomic fundamentals
stemming, for example, from high oil prices. A possible weakening
of global financial market stability in the face of progressive
monetary tightening could also work to magnify and propagate
problems associated with inadequate policy performance of
individual emerging market economies. Such possibilities are real
as the default rates of sub-investment grade borrowers are likely to
increase—partly because of the wave of high yield issuance in

previous years—and as credit derivatives, which have proliferated
in recent years and whose pricing has depended on relatively
untested models and default correlation assumptions, are vulnerable
to corrections.

None of the circumstances mentioned above necessarily
points to major market disturbances or credit events in the
period immediately ahead. Nevertheless, in conjunction with
gradual increases in risk aversion in world financial markets that are
likely to occur, the risk of disorderly exchange rate movements
among major currencies stemming from global current account
imbalances, and a bunching of key elections in emerging market
countries in the next 15 months, such possibilities are a cause for
concern.


Global Economic Environment

Global recovery has continued in 2005, albeit at a more
moderate pace than in 2004 (Chart 2). Strong balance sheets and
favorable profit margins have been supportive of investment activity
while consumption has held up well in the face of higher energy
costs. Global growth is expected to moderate further in 2006. The
pattern of uneven growth and the policies responsible for such a
pattern, which together have contributed to a widening in global
current account imbalances, remain a risk going forward.

• The United States has continued to be the engine of growth for
the world economy with projected growth for this year the
highest in the G7. Although GDP growth slowed to an

annualized rate of 3.3 percent in the second quarter, the strength
of final demand in that quarter and subsequent activity
indicators suggest that, even after allowing for the effects of
Katrina, full-year GDP growth in the vicinity of 3½ percent is
well within reach. Growth momentum is expected to slow
somewhat next year on an annual average basis as high oil
prices finally bite into consumption in the situation where the
savings rate has hit rock bottom. Business fixed investment is
likely to continue to play a key role as a source of growth.

“Although the general conditions in emerging markets
as a whole remain broadly conducive to growth and
stability, less favorable economic performance and
troublesome developments, including the persistence
of high debt ratios and a tendency to hold back on
structural reforms, have been observed in some
countries.”

“The United States has continued to be the engine of
growth for the world economy with projected growth
for this year the highest in the G7.”
Chart 2: Industrial Countries’ Real GDP Growth
(percent change from previous year)
-2
-1
0
1
2
3
4

5
00 01 02 03 04 05f 06f
U.S. Japan Eurozone
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Capital Flows to Emerging Market Economies
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September 24, 2005

• The narrowing of the output gap that has taken place in the
United States this year is not being replicated in other major
industrial countries, except perhaps in Japan. Indeed, recovery
in the Eurozone has faltered with real GDP growth projected at
1.3 percent in 2005. While the employment situation has
improved a little, the same cannot be said for consumption,
which has been held back in part by higher oil prices, which
have not been attenuated of late by a strengthening euro.
Growth next year is projected to reach 1.6 percent—with
Germany showing some strength—supported by export volume
growth that should benefit from the lagged effects of earlier
exchange rate developments. A major strengthening of
domestic demand growth is not expected, however.

• Japan seems poised to register its first sustained economic
recovery since the bursting of the bubble, albeit with wide
gyrations in quarterly growth, which may reflect in part
problems with seasonal adjustment. With signs of
strengthening in the jobs market and in wages and salaries,
growth this year is expected to reach 2¼ percent, underpinned
by moderately strong private consumption and business

investment. Forward-looking indicators suggest that economic
growth next year will continue at this year’s pace. Survey data
show that business confidence is increasing and that export
growth is likely to rebound as the manufacturing sector reacts
favorably to global IT sector adjustment. If the current
reduction in deflation continues, it should come to an end in
2006, if not earlier.

Emerging market growth this year is projected at 5.9 percent
(Chart 3). This is nearly one percentage point lower than in 2004,
when growth reached a 20-year high.

• Emerging Europe is likely to experience the most visible fall-
off in growth to 4.9 percent from 6.8 percent in 2004, reflecting
slower export growth to the euro area and some moderation in
domestic demand, most noticeably in Turkey (Table 2). In
2006, real GDP growth is expected to remain nearly unchanged
from this year’s pace.

• Growth in Latin America is projected to decline to 4.3 percent
this year after reaching nearly 6 percent in 2004. A tightening
of monetary policy in both Brazil and Mexico has dampened
demand growth. Growth momentum, however, has been
supported in countries dependent on commodity exports by
terms-of-trade gains. With the exception of Brazil, all countries
in Latin America are likely to experience a moderation in
growth in 2006.

• Output growth in emerging Asia is expected to remain robust
this year at 7.2 percent, marginally lower than 7.5 percent last

year. Korea and Malaysia are projected to have the weakest
growth in the region (at 3.5 percent and 4.3 percent,
respectively) while China is likely to register growth of
9.3 percent, down slightly from a rapid pace of 9.5 percent last
year. Regional growth next year is projected to fall below
Table 2
Emerging Market Economies' Output Growth
(percent change from previous year)
2003 2004 2005f 2006f
Real GDP 5.3
6.7 5.9 5.5
Latin America 1.7 5.9 4.3 3.9
Europe 5.5 6.8 4.9 4.8
Africa/Middle East 4.1 4.2 4.2 4.5
Asia/Pacific 7.4 7.5 7.2 6.8
f = IIF forecast
Chart 3: Emerging Market Economies’
Real GDP Growth
(percent change from previous year)
0
1
2
3
4
5
6
7
98 99 2000 01 02 2003 04 05f 2006f
“Japan seems poised to register its first sustained
economic recovery since the bursting of the bubble,

albeit with wide gyrations in quarterly growth, which
may reflect in part problems with seasonal
adjustment.”

Chart 3: Emerging Market Economies’
Real GDP Growth
(percent change from previous year)
0
1
2
3
4
5
6
7
98 99 00 01 02 03 04 05f 06f
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Capital Flows to Emerging Market Economies
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September 24, 2005

7 percent for the first time since 2002 with China’s growth
slowing to 8.5 percent.

• Output in the Africa/Middle East region in 2005 is likely to
grow at 4.2 percent, the same as last year, and step up to
4.5 percent next year.

Interest Rates

Somewhat surprisingly, yields on 10-year U.S. Treasury
bonds have not begun a clear upward trend, although there
have been a few episodes of visible but temporary spikes (Chart
4). This pattern seems to indicate the lack of conviction on the part
of market participants about the robustness of U.S. growth. Foreign
official demand as well as the demand of insurance companies and
pension funds to increase their holdings in long-term bonds to
reduce duration mismatches is also considered as a factor
contributing to the absence of sustained upward pressure on bond
yields. However, a sudden rise in inflation expectations or a
weakening in foreign demand for U.S. securities, resulting from a
change in policy by China or other Asian countries, could prompt
significant financial market deleveraging and downward adjustment
in asset prices, especially those of riskier assets. This in turn could
lead to a deterioration in the financial condition of emerging market
countries, particularly those with lower credit ratings and in need of
external financing.

• Our base case scenario sees the federal funds rate rising
toward a 4.0-4.25 percent range in the course of the first half of
2006, assuming that the increase in the core personal consump-
tion expenditure deflator hovers around 2.0 percent. Given the
recent movement in unit labor costs and several components of
producer prices, this assumption is not without risks.

• The yield on 10-year Treasury bonds is seen as rising to the
5.0 percent by the second half of 2006, and to a 5¼-5½ percent
range by mid-2007 in step with a progressive narrowing in the
margin of economic slack.

• Market interest rates in Japan are projected to remain broadly
unchanged while rates in the Eurozone are likely to show a
slight upward trend.

Current Account Balance

The continued disparity in growth prospects for the United
States relative to the Eurozone and Japan implies underlying
forces working toward a further widening of the U.S. current
account deficit (Chart 5). While the dollar has been firm for most
of this year, the lack of prospects for coordinated policy action by
major economies raises the possibility of a disorderly depreciation
of the dollar in due course. Such a depreciation could push U.S.
interest rates—both the federal funds rate and market rates—well
beyond current expectations with adverse consequences for EMBIG
spreads. Such a depreciation would also weaken output growth in
-7.0
-6.0
-5.0
-4.0
2000 2001 2002 2003 2004 2005
Chart 5: U.S. Current Account Balance
(percent of GDP)
“The continued disparity in growth prospects for the
United States relative to the Eurozone and Japan
implies underlying forces working toward a further
widening of the U.S. current account deficit.”

Chart 4: 10-year U.S. Treasury Bond Yields

(percentage points)
3.5
4
4.5
5
Jan-04 Jul-04 Jan-05 Jul-05
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Capital Flows to Emerging Market Economies
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September 24, 2005

the Eurozone and Japan while higher U.S. interest rates would
dampen U.S. domestic demand. Both of these developments would
reduce growth of exports and output in emerging markets. Wider
EMBIG spreads and weaker growth would have a negative impact
on the debt dynamics of those emerging market economies with
high debt levels.

• Adjustment in U.S. fiscal policy is but one component of
what is needed to reduce the current global payments
imbalance. Improving growth prospects for the Eurozone
depends critically on structural reforms—particularly those
pertaining to labor markets—that promote more flexible and
responsive economies. In Japan, further structural reforms,
building on those that have helped improve balance sheets of
the corporate sector and banking system, are needed to boost
growth prospects.

• Emerging markets will need to do their part as well, for

example, through corporate and banking reform in Asia, better
financial regulation and supervision in central Europe, and a
more user-friendly investment and corporate governance
environment in Latin America. In the meantime, the aggregate
current account surplus of emerging markets included in this
capital flows exercise is projected to reach 2.4 percent of GDP
this year, up from 2.1 percent in 2004. Double-digit export
growth is expected for the third consecutive year. Growth of
remittances is likely to remain strong, constituting the single-
largest source of foreign exchange, excluding merchandise
exports, in a number of countries. Remittances are expected to
remain resilient next year despite a projected decline in the
overall current account surplus to 2.1 percent of GDP.

Oil Prices

The impact of higher oil prices on global activity and
inflation so far has been relatively mild compared to earlier
episodes in the 1970s and 80s. Oil prices in real terms are still
below those reached during the past three decades (Chart 6).
Second-round effects of higher oil prices on inflation have so far
been held in check by several factors, including limited pricing
power of companies, adequate labor supply and benign inflation
expectations.

In looking at the possible future trend of oil prices, a number of
factors need to be considered. The increasing concentration of
global growth on several oil-intensive economies in Asia has
already noticeably accelerated the growth of global oil demand.
Although the International Energy Agency (IEA) and others are

forecasting slower growth in demand for oil in the coming year, this
market has been known to surprise analysts. On the supply side,
despite increased production by non-OPEC countries, the global oil
supply has become progressively tighter, reflecting a long period in
which there has been low investment in the sector. The lowest level
of OPEC’s spare capacity in 25 years has accentuated market
participants’ reaction to possible terrorist threats to oil supplies from
the Middle East and recurrent production disturbances in non-OPEC
Chart 6: Real Oil Prices
(2004 U.S. dollars)
$0
$20
$40
$60
$80
$100
70 75 80 85 90 95 00 05
“Second-round effects of higher oil prices on inflation
have so far been held in check by several factors,
including limited pricing power of companies,
adequate labor supply and benign inflation
expectations.”

“Adjustment in U.S. fiscal policy is but one component
of what is needed to reduce the current global
payments imbalance.”

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Capital Flows to Emerging Market Economies

Page 6
September 24, 2005

countries. Temporary refinery constraints have also contributed to
oil market jitters.

• Brent crude oil prices are expected to fall to about $60 a
barrel by end-2005 and average $60 a barrel in 2006. This
forecast assumes that the increase in world demand for oil will
hover around 2 percent next year, following an increase of
1.6 percent in 2005 as expected by the IEA. Our price
assumption also depends on OPEC increasing its output by
roughly 0.4 million barrels per day in 2006 with an increase of
1.4 million barrels per day from non-OPEC producers.

• A further rise in oil prices could lead to a drag on growth.
The IEA estimates that every $10 a barrel rise in the price of
oil, sustained for one year, would subtract roughly 0.5 percent
from world GDP as its direct impact. As has been pointed out
by the IEA and others, a sharp rise in oil prices could have a
significant and disproportionate negative impact on the growth
prospects for key importing emerging market countries.


Outlook for Major Components
of Capital Flows

Since our last update on capital flows to emerging market
economies at the end of March, we have revised our projection
for net private capital flows in 2005 to $345 billion from

$311 billion. The most notable change in the composition of this
external financing is that commercial bank net lending has been
revised upward by $17 billion with nearly all of it going to Asia.
Net nonbank credit flows—mostly bonds—have also been revised
upward by $11 billion as borrowers have taken advantage of low
spreads to prefinance obligations due in 2006. Portfolio equity
flows are also more robust than previously expected.

Key features of the main categories of net private capital flows
to emerging market economies this year and next are as follows:

• Net direct investment (projected at $149 billion this year and
$146 billion next year) is expected to account for 43 percent of
all private capital flows to emerging markets in 2005 and
slightly more in 2006. China will remain the largest recipient
of foreign direct investment among emerging market
economies, accounting for one-third of net flows.

• Commercial bank net lending is projected to reach a nine-
year high of $63 billion this year before slowing down to
$59 billion in 2006. Emerging Europe is likely to be the major
recipient of commercial bank funding as companies continue to
rely on debt financing. In 2006, positive net lending to Latin
America is projected to take place for the first time since 2000.

• Despite an increase in amortization payments this year, net
nonbank credit flows are likely to reach an all-time high of
more than $90 billion. Net flows are expected to recede next
“As has been pointed out by the IEA and others, a
sharp rise in oil prices could have a significant and

disproportionate negative impact on the growth
prospects for key importing emerging market
countries.”
“Commercial bank net lending is projected to reach a
nine-year high of $63 billion this year before slowing
down to $59 billion in 2006.”

“China will remain the largest recipient of foreign
direct investment among emerging market economies,
accounting for one-third of net flows.”

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Capital Flows to Emerging Market Economies
Page 7
September 24, 2005

year to $76 billion in large part because of reduced borrowing
by countries in emerging Europe, one of which, Poland, used
the bond market extensively this year to finance large
prepayments of debt to Paris Club members.

Net repayments to official creditors are projected to reach a
record high this year of more than $50 billion, with Poland and
Russia together accounting for $31 billion of the total. Net
repayments are projected to be cut in half in 2006.

From a geographical perspective, net private capital flows to
Asia are expected to account for 42 percent of total flows to
emerging markets this year, down from 52 percent in 2004

(Table 3). An increase to 46 percent is projected for next year as
flows to China pick up after a moderate dip this year. In terms of
other regions:

• Private capital flows to emerging Europe are expected to reach
nearly $132 billion in 2005, representing 38 percent of total net
capital flows to emerging markets. This share is likely to
decline to 35 percent in 2006, but remain substantially above
the 10-year average of 24 percent.

• Latin America’s share of total net private flows is expected to
remain in the range of 13-16 percent through 2006, with
Mexico continuing to garner the largest share of net inflows to
the region while Brazil closes the gap as it attracts increasing
investor interest.

• Private flows to the Africa/Middle East region are likely to
remain small at 4-6 percent of total flows, with much of it
accounted for by South Africa.

Regional notes on pages 8 and 9 provide greater details, including
key features of the composition of net private capital flows as well
as total amounts.

Direct Investment

The generally favorable outlook for economic growth in
emerging market countries, as well as improving confidence on
the part of long-term investors in emerging markets policy
performance, has attracted increasing amounts of direct equity

investment. Thus, after falling to a seven-year low of $96 billion in
2003, direct investment is expected to rise for the second
consecutive year, reaching $149 billion in 2005—the highest level
since 1999 (Chart 7). Direct investment is projected to remain
nearly unchanged in 2006 at $146 billion. Traditional mergers and
acquisitions and green investment will constitute the bulk of
investment inflows. Larger amounts of cross-border transactions
between the related entities within the ownership structures of
multinational corporations also appear to be taking place. In
looking for investment opportunities there is an increasing tendency
for companies to search in the more populous emerging market
countries in the belief that these countries will provide an expanding
customer base in addition to a cost advantage needed as an export
“After falling to a seven-year low of $96 billion in
2003, direct investment is expected to rise for the
second consecutive year, reaching $149 billion in
2005—the highest level since 1999.”

Table 3
Financial Flows to Emerging Market Economies by Region, Ne
t
(billions of U.S. dollars)
2003 2004 2005
f 2006f
Private flows 213.7 317.4 345.2 317.8
Latin America 26.8 31.0 46.2 49.9
Europe 65.1 108.9 131.5 110.8
Africa/Middle East 3.6 11.0 21.6 12.3
Asia/Pacific 118.
2 166.4 145.9 144.8

Official flows -21.4 -30.6 -50.4 -24.2
Latin America -0.6 -10.3 -14.0 -9.0
Europe -3.4 -9.1 -34.6 -15.0
Africa/Middle East -2.6 -2.5 -1.7 -2.4
Asia/Pacific -14.9 -8.7 -0.1 2.
2
f = IIF forecast
Chart 7: Net Direct Investment by Region
(billions of U.S. dollars)
0
40
80
120
160
EME LA A/ME Asia Europe
2003 2004 2005f 2006f
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Capital Flows to Emerging Market Economies
Page 8
September 24, 2005

Emerging Europe

A continued strengthening of foreign direct investment and
nonbank creditor flows should help raise net private capital
flows to a record high $132 billion this year before slowing
to an expected $111 billion in 2006.

• With the exception of Bulgaria, all countries in the region

are likely to experience a slowdown in economic growth
this year, primarily because of a weakening in the net for-
eign balance of most countries. In 2006, real GDP in
emerging Europe is expected to grow 4.8 percent, nearly
identical to this year’s projected outcome.

• Privatization activity in the Czech Republic and Turkey is
largely behind the expected pickup in direct investment
this year. Proximity to major markets in Western Europe
and still relatively low labor costs are attracting direct in-
vestment in the region. Direct investment is forecast to
hold steady next year at $34 billion.

• Reserve accumulation is slated to accelerate in 2005 as a
rise in net private capital flows is augmented by a reduc-
tion in net resident lending abroad. Reserve accumulation
is projected to reach a record high $73 billion this year,
bringing the stock of reserves to nearly $335 billion, rep-
resenting 5.8 months of imports of goods, services and
transfers. A smaller, expected current account surplus
next year, along with a reduction in net private capital in-
flows, will hold down reserve accumulation to less than
$62 billion.
Asia/Pacific

Net private capital inflows are set to moderate to $146 billion
this year from $166 billion in 2004 as flows in all categories
of investment are likely to recede. Capital flows are expected
to remain at this year’s level in 2006.

• Regional growth is likely to stay above 7 percent for the
third consecutive year with China once again expected to
experience the fastest growth among our survey countries
at 9.3 percent. A tapering off of activity in China next
year will limit regional growth to a projected 6.8 percent.

• Capital flows to the region continue to be dominated by
direct investment, which is expected to account for more
than 40 percent of flows this year. China remains the
major recipient of direct investment in emerging Asia as
these flows, along with the mobilization of the labor
force, have transformed the country into a regional export
base.

• Despite a slowdown in capital flows to the region this
year, reserve accumulation is expected to exceed $280
billion for the second consecutive year as the aggregate
current account surplus reaches 3.7 percent of GDP, up
from 3.2 percent in 2004. Reserve accumulation is
projected to hit a record high $312 billion in 2006,
bringing the region’s stock of reserves to $1.7 trillion.

(See separate box on page 10 for details of China’s external
financing.)
Table 4
Europe: External Financing
(billions of U.S. dollars)
200
3 2004 2005f 2006f
Current account balance -1.3 6.3 7.9 2.6

External financing, net:
Private flows, net 65.1
108.9 131.5 110.8
Equity investment, net 8.1 28.1 41.7 41.4
Direct investment, net 6.0 23.3 34.5 34.5
Portfolio investment, net 2.0 4.8 7.2 6.9
Private creditors, net 57.0 80.9 89.8 69.4
Commercial banks, net 27.
3 37.9 39.2 31.1
Nonbanks, ne
t 29.7 43.0 50.6 38.3
Official flows, net -3.4 -9.1 -34.6 -15.0
IFIs -0.1 -2.9 -7.5 -2.7
Bilateral creditors -3.
3 -6.2 -27.1 -12.3
Resident lending/other, net
1
-24.3 -47.8 -32.0 -36.8
Reserves (- = increase) -36.1 -58.4 -72.8 -61.6
f = IIF forecast
1
Including net lending, monetary gold, and errors and omissions.
Table 5
Asia/Pacific: External Financing
(billions of U.S. dollars)
2003 2004 2005
f 2006f
Current account balance 99.2 117.3 151.0 164.5
External financing, net:
Private flows, ne

t 118.2 166.4 145.9 144.8
Equity investment, net 91.6 95.9 93.8 96.4
Direct investment, net 55.8 64.2 63.9 64.0
Portfolio investment, net 35.8 31.8 29.9 32.4
Private creditors, ne
t 26.6 70.5 52.2 48.4
Commercial banks, ne
t 13.8 37.5 28.2 22.6
Nonbanks, ne
t 12.8 32.9 24.0 25.8
Official flows, ne
t -14.9 -8.7 -0.1 2.2
IFIs -10.1 -4.7 -2.7 -0.8
Bilateral creditors -4.8 -4.0 2.5 2.9
Resident lending/other, net
1
-12.1 25.9 -14.8 1.1
Reserves (- = increase) -190.4 -300.9 -282.0 -312.5
f = IIF forecast
1
Including net lending, monetary gold, and errors and omissions.
The Institute of International Finance, Inc.

Capital Flows to Emerging Market Economies
Page 9
September 24, 2005

Latin America

Increases in equity investment for the third consecutive year

and a reduction in net outflows to commercial banks will
contribute to a significant expansion of net private flows this
year to an expected $46 billion from $31 billion in 2004. A
further moderate increase in flows is projected for 2006.

• All countries in the region are likely to experience some
degree of a slowdown in economic activity this year with
Uruguay and Venezuela expected to see the biggest
declines in growth rates, following significant rebounds in
activity in 2004. Regional growth is projected to dip to
4.3 percent in 2005 from 5.9 percent last year and slow
further to 3.9 percent in 2006.

• Net nonbank creditor inflows are expected to increase for
the second consecutive year to $11 billion from $9.5
billion in 2004. Reduced financing needs and improved
public balance sheets should limit nonbank creditor
flows—mostly bonds—to less than $9 billion next year
with an increasing likelihood of more local currency-
denominated global bond issuance.

• A significant increase in net resident lending, particularly
from Mexico and Venezuela, is projected to limit reserve
accumulation in the region to about $17 billion this year,
down from more than $22 billion in 2004. A further
decrease in reserve accumulation is expected next year as
the current account surplus shrinks to only 0.3 percent of
GDP, down from 1.1 percent in 2005.
Africa/Middle East

Net private capital flows to the region are expected to
approach nearly $22 billion this year, nearly double the
amount received in 2004. A surge in direct investment is
responsible for a significant portion of the overall increase in
flows.

• Growth in the region will hold up at relatively high levels
this year with a further acceleration in regional growth
expected next year. Egypt should see the sharpest
increase in growth, reflecting improved policy
implementation and a rebound in tourism.

• The acquisition of one of South Africa’s major banks, as
well as foreign interest in the natural resource sector, has
been pivotal to the significant pickup in equity investment
in the region this year. Bond flows as well as commercial
bank lending are also expected to rise this year before
dropping in 2006.

• The region’s current account is forecast to remain healthy
in 2005 with a surplus of 2.5 percent of GDP. An
expected shift in the terms of trade is projected to result in
a smaller current account surplus in 2006. Reserve
accumulation is likely to reach $29 billion this year, up
from $18 billion in 2004. Reduced capital flows and a
smaller current account surplus will limit reserve
accumulation next year to less than $16 billion.
Table 6
Latin America: External Financing
(billions of U.S. dollars)

2003 2004 2005
f 2006f
Current account balance 10.9 20.2 23.2 6.9
External financing, net:
Private flows, net 26.8
31.0 46.2 49.9
Equity investment, net 24.8 36.4 39.8 37.8
Direct investment, net 30.1 43.3 41.1 41.8
Portfolio investment, net -5.3 -6.9 -1.3 -3.9
Private creditors, net 1.9 -5.4 6.4 12.1
Commercial banks, net -13.2 -14.9 -4.8 3.4
Nonbanks, net 15.1 9.5 11.2 8.6
Official flows, net -0.6
-10.3 -14.0 -9.0
IFIs 4.8 -7.6 -12.9 -8.1
Bilateral creditors -5.4 -2.7 -1.0 -0.9
Resident lending/other, net
1
-3.7 -18.6 -38.0 -35.5
Reserves (- = increase) -33.4 -22.4 -17.4 -12.2
f = IIF forecast
1
Including net lending, monetary gold, and errors and omissions.
Table 7
Africa/Middle East: External Financing
(billions of U.S. dollars)
2003 2004 2005f 2006f
Current account balance 9.1
8.0 12.3 6.7
External financing, net:

Private flows, net 3.6
11.0 21.6 12.3
Equity investment, net 4.4 7.1 16.0 8.9
Direct investment, net 3.9 1.5 9.5 5.6
Portfolio investment, net 0.5 5.6 6.5 3.3
Private creditors, net -0.
8 3.9 5.6 3.5
Commercial banks, net -2.5 0.5 0.9 0.7
Nonbanks, net 1.
8 3.3 4.7 2.8
Official flows, net -2.6 -2.5 -1.7 -2.4
IFIs -1.3 -1.2 -0.8 -0.8
Bilateral creditors -1.3 -1.3 -0.9 -1.5
Resident lending/other, net
1
2.5 1.8 -2.9 -1.0
Reserves (- = increase) -12.7 -18.3 -29.2 -15.6
f = IIF forecast
1
Including net lending, monetary gold, and errors and omissions.