Emerging Markets Benefit from Positive Capital Inflows
Despite significant global macro uncertainty and volatility, emerging markets (EM) are experiencing moderately positive capital inflows. These inflows are driven by a combination of factors, including a depreciating US dollar, monetary policy easing in advanced economies, and high real yields in several EMs.
What’s Behind the Inflows?
According to Qatar National Bank (QNB), the current cycle of monetary policy easing across major advanced economies is one of the key drivers of capital inflows into EMs. The bank believes that these tailwinds will continue over the medium-term, particularly as the US engages in efforts to re-balance its economy via lower external deficits and manufacturing onshoring.
A Shift in Capital Flows
In recent years, EMs have suffered from significant volatility in capital flows due to monetary instability, geopolitical uncertainty, and a lack of broader risk appetite from global investors. However, according to the Institute of International Finance (IIF), non-resident portfolio inflows to EMs have shifted from negative territory to positive in late 2023 and continue to be moderately strong in 2025.
Factors Contributing to Inflows
There are two main factors contributing to the inflows into EMs. Firstly, a softer US dollar is bolstering the attractiveness of higher-yielding EM assets, providing a tailwind for capital inflows. A weaker dollar reduces the currency risk for investing in EMs and lessens the burden of debt services of US dollar-denominated debt for sovereigns and corporates in EMs.
Monetary Policy Easing and Real Yields
Secondly, the easing of monetary policy by major central banks is resulting in lower yields and looser financial conditions in advanced economies, increasing the relative attractiveness of EM assets. Several large EMs, particularly in Asia and Latin America, are offering yields that are significantly higher than their inflation rates, providing higher gain potential and reassuring investors against potential risks of undue currency depreciation.
The Carry Trade
The carry trade, which involves borrowing from low-yielding currencies to invest in high-yielding EM currencies, seems to be the dominant feature of capital flows to EMs so far in 2025. The vast majority of inflows are concentrated in debt rather than equity and in jurisdictions with more floating currencies as well as higher real yields.
Conclusion
In conclusion, emerging markets are benefiting from positive capital inflows driven by a combination of factors, including a depreciating US dollar, monetary policy easing, and high real yields. As the US continues to re-balance its economy and major central banks maintain their easing cycles, these tailwinds are likely to continue, supporting further capital inflows into EMs. The carry trade is expected to remain a dominant feature of capital flows to EMs, with investors seeking higher yields and reassurance against potential risks. Overall, the outlook for EMs remains positive, with moderately strong capital inflows expected to continue in the medium-term.
