LONDON (Reuters) - A surging dollar is likely to hit foreign investment into emerging markets this year, the Institute of International Finance said on Wednesday, cutting its capital inflow forecast for this year by $43 billion to $1.22 trillion.
The Washington DC-based group, an authoritative tracker of capital flows to and from emerging markets, called the dollar’s rise and higher U.S. yields “a paradigm shift” for investors.
As a result, capital inflows would likely hold at the levels seen last year, it said, cutting its previous forecasts from February.
“Prospects for non-resident capital inflows to emerging markets this year have deteriorated...Rising U.S. bond yields and a stronger dollar have prompted a ‘sudden stop’ in portfolio flows since mid-April,” the IIF said in a report.
As a share of gross domestic product, capital inflows will fall to 3.7 percent from 4.2 percent in 2017, it added.
Since mid-April, the dollar has strengthened around 5 percent while U.S. 10-year yields have risen past the key 3 percent mark for the first time in four years. That is exerting huge pressure on emerging markets, pushing currencies lower and bond yields higher.
Argentina, one of the worst-hit countries, has been forced to seek assistance from the International Monetary Fund.
The IIF predicts emerging bond markets to be worst hit, with inflows of $255 billion this year, down from last year’s record $315 billion. Monthly inflows so far this year averaged $13 billion through April, it noted, half year-ago levels.
A 100 basis-point rise in U.S. yields would cut flows to emerging debt by $20 billion, the IIF suggested, noting that huge inflows to the sector last year had made it a relatively crowded trade.
It also cut forecasts for equity flows to $94 billion for 2018 but noted this would still be $8 billion above last year.
The group remains optimistic on future prospects, however, predicting the developing world to receive inflows of $1.35 trillion next year, thanks to still-firm strong economic growth and trade.
Another bright spot is “direct”, bricks-and-mortar investment or FDI, which makes up 40 percent of emerging markets’ capital flows. The IIF revised up previous forecasts for 2018 FDI by $43 billion to $523 billion, the highest in three years.
“The robust growth differential between emerging and mature markets will be supportive, while the modest recovery in commodity prices has been another key factor,” it added.
With overall capital inflows holding steady at last year’s levels and most emerging central banks reluctant to intervene in currency markets, the IIF said it expected their hard currency reserves to rise in 2018 by $220 billion, most of it in China.
Reporting by Sujata Rao; Editing by Toby Chopra