Catalog

Capital flows and financial markets

The global investment climate for developing Asia remains favorable. Despite the most recent correction in February-March, emerging market asset prices have kept their earlier large gains. In 2006, emerging market equity prices again staged a strong rally after a brief midyear sell-off. The strong performance of emerging Asian market equities partly reflected external demand and was accompanied by robust capital inflows (Figure 1.2.11). Net private capital flows to emerging Asia amounted to $197.3 billion, only slightly down by 3.9% from the previous year, due to slightly smaller foreign direct investment flows. However, with its strong growth outlook, the region continues to be the primary recipient of private equity investment, attracting again more than 60% of net portfolio equity investment flows to emerging market economies in 2006.

Relatively low interest rates and benign liquidity conditions in capital markets have kept private credit flows generally buoyant, benefiting emerging Asian borrowers. Credit spreads remained near record lows for emerging market issuers through most of 2006 (Figure 1.2.12). While the region's strong fiscal position limited the need for new issuance of sovereign debt, corporate issuers took advantage of low funding costs. Foreign investors' Asian bond purchases (which account for a majority of private creditor nonbank flows) were boosted by expectation of currency appreciation. Although Asian corporate borrowers will have ready access to bank credit, borrowing from banks abroad is expected to slow in 2007, mainly due to government measures to curtail investment in the PRC.

Asian currencies strengthened further against the US dollar in 2006. Gains ranged from 1.9% for the Indian rupee to 13.8% for the Thai baht (Figure 1.2.13). Robust performance of both current and capital accounts underpinned the strength of most Asian currencies. Narrowing interest rates continued to weigh on the dollar, which fell by 11.7% against the euro in 2006. Significant interest rate differentials between the US and Japan limited the dollar's fall against the yen to only 0.8%. Expectations for strong growth will continue to underpin the strength of Asian currencies in 2007, as will narrowing interest rate differentials, due to monetary tightening in some countries.