Ukraine War May Force New Realignment of EM Capital Flows

This shift reflects geopolitical concerns and anxiety that the government’s zero COVID policy could weigh on China in the medium term.

Ukraine War May Force New Realignment of EM Capital Flows
Photo by noah eleazar / Unsplash

The Institute of International Finance says in the weeks after Russia invaded Ukraine, it noted a possible realignment in EM capital flows away from China (Exhibit 1), even as flows to the rest of EM remained relatively robust (Exhibit 2).

At the time, it was an open question if outflows from China were a short-term phenomenon or part of a more structural realignment. Increasingly, this question is being settled in favor of the latter, with market participants looking at China in a new light.

This shift reflects geopolitical concerns and anxiety that the government’s zero COVID policy could weigh on China in the medium term.

Separately, there is lots of debate on what lessons to learn from sanctions on Russia. In the early stages of the war, there was lots of excitement that export restrictions from the West could materially hamper Russia’s ability to import goods.

However, since their low point in April, Russia’s imports have risen 90 percent and are only around 10 percent below pre-war levels (Exhibit 3). In the meantime, Russia’s export revenues have stayed very elevated (Exhibit 4), so that the current account surplus is still high relative to history (Exhibit 5), even with the rebound in imports.

Indeed, three-quarters of the rise in Russia’s current account surplus in 2022 versus 2021 is due to exports rather than import compression.

As a result, there is lots of debate on what kind of measures might be most effective in curtailing current account surplus countries, with the G7 oil price cap garnering more favorable reviews than just a few months ago.

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