Goldman Sachs Sees Record `Wall of Money' Headed Toward Emerging Markets

Net capital inflows into emerging market economies are running at record levels, pushing up asset prices and raising the risk governments may impose capital controls, Goldman Sachs Group Inc. said in a research report today. 

Capital inflows into emerging markets are running at $575 billion a year, more than ever before and 20 percent higher than before the world financial crisis, according to an e-mailed report by Robin Brooks, a senior foreign exchange strategist for Goldman in New York. Low interest rates in the developed world are leading investors to seek higher returns in faster-growing emerging economies, he said. 

“Our baseline case remains of moderate growth in the advanced economies,” Brooks said. “This is contributing to direct ‘a wall of money’ to emerging markets in search of higher yields.” 

Capital inflows help emerging economies by providing cheap financing, lowering bond yields and boosting domestic demand, Goldman said. They also push currencies to appreciate and create inflationary pressures which could lead some countries to impose controls on funds entering from abroad, Brooks said. 

“Some emerging markets have already resorted to capital controls, and the risk of further such measures remains,” he said. 

Emerging-market sovereign bonds have returned 11.8 percent this year, according to JPMorgan Chase & Co.’s EMBI+ index. Stocks included in the MSCI Emerging Markets Index have risen 2.3 percent so far in 2010, compared to a 2.8 percent decline in the MSCI World Index of 24 developed countries. 

Capital Controls

In June, South Korea tightened limits on maximum holdings of currency derivatives by banks in an attempt to reduce the volatility of capital inflows. The same month, Indonesia’s central bank said it would insist investors in its one-month bills hold the securities for at least four weeks. Brazil imposed a 2 percent tax on foreign investors’ purchases of shares and bonds in October last year. 

South Africa’s ruling African National Congress proposed in a discussion document July 30 that an inflow tax be considered to help curb the rand’s appreciation. The currency has strengthened more than 30 percent against the dollar since the beginning of 2009. National Treasury Director-General Lesetja Kganyago said in September the country relies on the foreign money to finance its current-account deficit, and shouldn’t impose a tax on the inflows. 

Goldman recommends investing in the currencies of Asian countries benefitting from growth in China, he said. Source: Bloomberg