Why EM Capital Inflows Are Here to Stay (in Asia at Least)

Summary

• Accelerating capital inflows through Q4 2020 were a key driver of EMFX.
• We expect inflows will remain strong in Asia driven by yield pickup, tech demand and economic outperformance.
• A more coherent US trade policy under the new Biden administration should also support Asian exports, the region’s C/A surpluses, and risk sentiment more broadly.

Bumper foreign inflows were a significant driver of Asia FX through late 2020 (Chart 1). The Bloomberg EM Capital Flows index was up 16.5% QoQ in Q4, pushing YTD inflows back into positive territory in December. Foreign inflows helped push EM equity markets to new highs and meant rising FX intervention for Asian central banks. We see several reasons why inflows should remain robust and EM Asia the main beneficiary.

Yield Pickup Remains Attractive in Parts of Asia

Despite the jump higher in US yields since the start of the year, Asia’s attractiveness as a carry play is secure. 10-year bonds in Indonesia and India are 517bps and 481bps above 10-year US Treasuries, down from earlier highs but still very attractive (Chart 2). India is widely expected to resume its easing cycle given the recent drop back in inflation. But with the RBI pulling back on liquidity provision in recent weeks and short-term rates rising, we expect a cautious approach on further easing. In Indonesia, the easing cycle is likely over, or close to, despite below-target inflation. And worries over the debt monetization and BI’s independence will keep yields elevated despite the very severe COVID situation.

China’s yield spread is unlikely to come under pressure either. Economic outperformance means the PBoC is already tightening liquidity. And with WIGB inclusion later in the year, portfolio inflows are set to increase substantially.

Of course, not all the EM high yielders are in Asia. Turkey, South Africa and Brazil all yield more than Indonesia and India (see my note on bond yields). But in contrast to Asia, a mixture of policy uncertainty, inflation and fiscal concerns, combined with particularly severe COVID outbreaks clouded the FX performance.

Asia’s Tech Dominance Will Attract Continued Inflows

The MSCI EM hit a fresh all-time high recently, in line with the S&P, and the gains have been broad-based across regions. But Asia’s dominance in global tech means several stocks, and country bourses, have done even better. Shares in Taiwan’s TSMC are up by more than 100% since 20 January, Korea’s Samsung by almost 50%, and China’s SMIC by 86% (all USD basis, Chart 3). The MSCI EM, by contrast, is up 20%.

Last week, TSMC announced its 2021 investment spend at a very large $28bn for this year, half of projected annual revenues. Such a large commitment was taken as a signal of confidence that the tech boom has a long way to go yet. Samsung also projected a 25% jump in profits in Q4 and is expected to continue to do well this year with rising chip prices (the DRAM index is up 4% YTD).

Investor expectations for outperformance in tech stocks will therefore be an important driver of Asian equity performance this year, and the region’s currencies.

Asia Has Much to Gain From a More Coherent US Trade Policy

Another factor supporting Asia FX in the coming months is the expectation for a more coherent trade policy under the new Biden administration. Asia’s supply chains are increasingly linked, and the RCEP trade deal is set to boost regional trade further in the coming years. US restrictions on Huawei under its former US president, Donald Trump, not only soured risk appetite but disrupted order books for TSMC and Samsung. Asian exports nevertheless did exceptionally well last year (in China’s case partly related to PPE goods) and Taiwan’s release of a 38.3% YoY reading for December export orders signals continued strength ahead.

While a smoother trade policy means inflows into the C/A, not the capital account, the effect could be on both sides of the BoP given improved risk sentiment. And while other EMs also have much to gain from a continued rebound in global trade, Asia’s more trade-dependent economies once again stand to benefit more than most.