1. Capital Flows to BRIC’s Countries Eduardo Pedreira Collazo BBVA Research Department Capital Flows Latin American and Caribbean Economic Association Mexico - November 2nd, 2006 Javier Santiso Economista Jefe/Director Adjunto Centro de Desarrollo OCDE Miguel A. Canela Facultat de Matemàtiques Universitat de Barcelona

2. 2 IntroductionI Focus on equity flows and preliminary resultsII VAR models: impulse response analysisIII ConclusionsIV

3. 3 Introduction  From a practitioners point of view, we consider extremely important to understand or unveil which factors underly capital flows to emerging markets, in particular equity flows.  Arguments are based on: international factors (global) and improvement in local emerging market fundamentals and institutions (pull)  More recently, excess liquidity and risk aversion.  Evidence regarding global-local factors is far from being conclusive about their relative importance. Very few evidence for liquidity or risk aversion.

4. 4 Introduction: Global liquidity and low interest rates The sharp decline in interest rates, and global “excess” liquidity has been underlying the surge of private portfolio flows in the last years. Investors' strategies – “search for yield” - deepened this trend, leading to record inflows in 2005 and 2006:1Q. Global Interest Rates (GDP-PPP weighted) vs. Stock of Liquidity (billions) -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% Mar-95Mar-96Mar-97 Mar-98Mar-99Mar-00Mar-01Mar-02Mar-03 Mar-04Mar-05 4000 5000 6000 7000 8000 9000 10000 11000 Interest rate Liquidity

5. 5 Introduction: Investors' risk appetite Investors' appetite for risk is not fixed over time. Besides that, they shift their portfolio allocation according to their expected return and perception of risk. “Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.” Alan Greenspan Global Risk Aversion Index Indice - IARG 64 assets: emeging (dollars) and developed (local curencyl) -6.0 -5.0 -4.0 -3.0 -2.0 0.0 1.0 2.0 3.0 4.0 jun-95 abr-96 feb-97 dic-97 oct-98 ago-99 jun-00 abr-01 feb-02 dic-02 oct-03 ago-04 jun-05 abr-06 Source: BBVA - Capital Flows. + aversion - aversion

6. 6 Introduction: In general, improved fundamentals

7. 7 Introduction: : Compressed EM sovereign spreads Sound macro fundamentals, high commodity prices and global growth, compressed EM spreads to historical levels, below 200 bp. EMBI+ (lhs) vs. US Corporate spread BAA (b.p.) 200 400 600 800 1000 1200 1400 1600 1800 Jan-95Jan-96Jan-97 Jan-98Jan-99Jan-00Jan-01Jan-02Jan-03 Jan-04Jan-05Jan-06 50 60 70 80 90 100 110 120 130 140 150 EMBIBAA-AAA

8. 8 IntroductionI Focus on equity flows and preliminary resultsII VAR models: impulse response analysisIII ConclusionsIV

9. 9 Focus on equity flows and preliminary results  Many researchers studied FDI, bonds or reserves, but much less efforts have been dedicated to explain private equity flows.  We are interested in Private Equity Flows  We use equity flows data from EPFR. Data are collected from a universe of 12,000 international, emerging markets and US funds, with more than $5.7 trillions in assets.  Investors are worldwide based and not only in US.

10. 10 Focus on equity flows and preliminary results  Correlation: flows, local & global factors  A previous exploratory factor analysis, based on principal components, points to a four- factor structure, with DEMBI, DCOMM and MSCIW standing alone, and the other five associated to the remaining factor. This structure accounts for an 85% of the variance.

11. 11 Focus on equity flows and preliminary results  Preliminary regression results

12. 12 IntroductionI Focus on equity flows and preliminary resultsII VAR models: impulse response analysisIII ConclusionsIV

13. 13  A negative shock in global interest rates is associated with increased cumulative flows in Latin America, whereas for Asia we observe a slight decrease. VAR: Cumulative impulse response analysis

14. 14  Even though the results are mixed, the evidence for Asia gives support for the expected return “chasing hypothesis”. VAR: Cumulative impulse response analysis

15. 15  Panel C give supports to the hypothesis that capital flows are, in part, momentum driven. In the short-run Latin America could suffer a slightly decrease, but in the long--run both regions will be benefited. VAR: Cumulative impulse response analysis

16. 16 VAR: Cumulative impulse response analysis  The effects of a negative shock in global interest rates in long--run returns is not clear. Panel D suggests that in the short-run these regions will experiment a lower cost of capital, but in the log--run these pressure effects might reverse themselves.

17. 17 VAR: Contemporaneous effects  The effects of a negative shock in global interest rates in long--run returns is not clear. Panel D suggests that in the short--run these regions will experiment a lower cost of capital, but in the log-run these pressure effects might reverse themselves.

18. 18 IntroductionI Focus on equity flows and preliminary resultsII VAR models: impulse response analysisIII ConclusionsIV

19. 19 Conclusions  Even though local factors have been improving during the last decade, the role of global factors is more important.  That is, equity capital can flow into (or out) of a country for reasons other than local fundamentals.  Risk appetite can have an important role  We found that positive returns shocks are followed by increased short-term equity capital flows, indicating a momentum effect (Bohn and Tesar 1996).  A negative shock in global interest rates is associated with increased cumulative flows to Latin America.  A negative shock in global interest rates will temporally reduce the cost of capital, but in the long-run this effect is reversed.