The rise in geopolitical risk and mounting trade tensions should have a counterpart in financial deglobalization, as investors pull back from global trouble spots. Most obviously, if friendshoring is a material phenomenon, this should be reflected in foreign direct investment flows, with, for example, stronger flows to Mexico, while China should see weaker inflows or even outflows. A similar trend may be visible in portfolio flows if Russia鈥檚 invasion of Ukraine makes markets wary of potential conflict zones. China and Taiwan are clearly a worry here. We assemble quarterly data on nonresident portfolio and direct investment flows to 25 emerging markets (EMs) from 2000 to 2024. These data show a healthy picture for EM overall, though China is a negative outlier. China has seen nonresident portfolio inflows weaken significantly from before Russia invaded Ukraine, in addition to foreign direct investment flows also softening recently. While these data points are consistent with financial deglobalization, a proper investigation will compare flows to a counterfactual linking them to underlying fundamentals such as interest and growth differentials. We leave a more definitive assessment of financial deglobalization for a follow-up post.
Financial deglobalization
We collect quarterly nonresident portfolio and direct investment flows to EM from 2000 to 2024. The portfolio data capture investment flows into stocks and bonds. We filter direct investment flows for reinvested earnings, which鈥攊n an important case like China鈥攁re often involuntary due to the difficulty of repatriating earnings. These reinvested earnings move up and down with profitability in foreign-owned subsidiaries and say little about genuine foreign direct investment (FDI). FDI excluding reinvested earnings is a better proxy for greenfield investment in EM. That said, the distinction between genuine FDI and reinvested earnings is often not clear-cut, an issue we will explore further in future posts.
Figure 1. Nonresident portfolio flows to emerging markets, in % GDP
Source: Haver Analytics
Figure 2. Nonresident portfolio flows to emerging markets excluding China, in % GDP
Source: Haver Analytics
Figure 1 shows the rolling, four-quarter sum of nonresident portfolio flows to all 25 EMs we examine. It scales these flows by the combined dollar-denominated GDP for these countries. Figure 2 is the same thing but excludes China in the numerator and denominator. Two conclusions emerge. First, portfolio flows to non-China EMs have been stable over the past decade, so financial deglobalization does not appear to be a material phenomenon. Second, China is a different story. Flows were on a rising trend before Russia invaded Ukraine, but that period is over. Perhaps this is because markets are now more attuned to geopolitical risk since Russia鈥檚 invasion of Ukraine, but it could equally well reflect China-specific factors, like the disappointing recovery since COVID-19 lockdowns were lifted. A similar divergence is evident in FDI flows. Figure 3 shows the rolling, four-quarter sum of FDI flows excluding reinvested earnings for the 25 EMs, again scaled by dollar-denominated GDP, while Figure 4 is the equivalent excluding China. True FDI鈥攅xcluding reinvested earnings鈥攊s quite stable for non-China EM, but is showing a precipitous decline for China recently.
Figure 3. Nonresident FDI to emerging markets, excluding reinvested earnings, in % GDP
Source: Haver Analytics
Figure 4. Nonresident FDI to emerging markets, excluding China and reinvested earnings, in % GDP
Source: Haver Analytics
Winners and losers in global capital flows
We now examine flows to individual countries. We compare flows before and after COVID-19, since the pandemic was such an important event for the global economy. Figure 5 shows annualized quarterly portfolio inflows from Q1 2020 to Q2 2024 in percent of GDP on the horizontal axis, while the vertical axis shows the same metric from Q3 2015 to Q4 2019. We thus look at the 4 1/2 years since the pandemic versus the 4 1/2 years before. Figure 6 is the same for FDI. In both cases, China (red) and Mexico (purple) lie above the diagonal, which leans against the friendshoring narrative. After all, Mexico should be attracting stronger inflows in this narrative, while China should be seeing weaker inflows. Commodity-heavy countries like Chile (CL), Colombia (CO), Malaysia (MY), and Saudi Arabia (SA) do better in the recent time window, while commodity importers like the Czech Republic (CZ), India (IN), and Turkey (TR) are doing worse.
Figure 5. Average of annualized quarterly nonresident portfolio inflows before and after COVID-19, in % GDP
Source: Haver Analytics
Figure 6. Average of annualized quarterly FDI inflow, excluding reinvested earnings, before and after COVID-19, in % GDP
Source: Haver Analytics
One widely held view is that FDI flows are more stable than portfolio flows. In this regard, capital flows to EM have become more stable in recent years. Figures 7 and 8 show portfolio inflows on the vertical axis and FDI inflows on the horizontal axis for 2020-2024 and 2015-2019, respectively. The more recent time window shows a shift downward and to the right, pointing to the relatively greater importance of FDI over portfolio flows. Of course, this no doubt is related to the post-COVID inflation scare and G10 central bank hikes, which weighed on portfolio flows to EM. Nonetheless, this says that the composition of EM inflows is more favorable now than it was in the run-up to COVID-19. Overall, portfolio flows to EM look quite healthy and stable, with the exception of China where financial deglobalization looks to be underway.
Figure 7. Nonresident portfolio vs. FDI inflows, 2020-2024
Source: Haver Analytics
Figure 8. Nonresident portfolio vs. FDI inflows, 2015-2019
Source: Haver Analytics
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Geopolitics and emerging market capital flows
November 8, 2024