BOK Shows Net Outflow Trend When Switching from Prolonged Easing to Tightening
Han Faces Significant Impact from Growth Rate Gap and Volatility Index with the US
Recent analysis shows that during the latest monetary policy tightening by the U.S. Federal Reserve (Fed), emerging markets experienced a significant net outflow of investment funds, unlike in the past. This tightening phase is interpreted as having increased external sector volatility due to the very rapid pace of interest rate hikes and the shift from a prolonged period of monetary easing to tightening.
On the 31st, the Bank of Korea (BOK) reported in its Monthly Bulletin of Statistics in a report titled "The Impact of U.S. Monetary Policy Tightening on Emerging Market Investment Fund Flows" that "Among the three U.S. Federal Reserve (Fed) monetary policy tightening phases since 2000, the first two saw net inflows of investment funds into emerging markets, but the recent tightening phase showed a significant net outflow." The study covered 41 emerging market countries, including Korea, for which investment fund flow data was available.
Typically, Fed monetary policy tightening is known to reduce dollar liquidity and cause capital outflows from emerging markets. However, according to the report, examining emerging market investment fund flows during past Fed tightening phases reveals net inflows instead.
The BOK reviewed investment fund flow data for emerging markets during the three Fed tightening periods (June 2004?June 2006, November 2014?April 2019, October 2021?September 2022). During the first two tightening phases, investment funds recorded net inflows of $11 billion and $148 billion respectively, whereas the ongoing tightening phase saw a net outflow of $402 billion. The increases in the federal funds rate (FFR) during each tightening phase were 0.16 percentage points, 0.04 percentage points, and 0.25 percentage points respectively, with the current phase having the largest rate hike.
Notably, net outflows of investment funds occurred both at the beginning of the second tightening phase, which followed a prolonged period of significant easing, and during the current tightening phase, where rate hikes exceeded market expectations.
Furthermore, empirical analysis showed that growth and risk-related variables had a significant impact on emerging market investment fund flows. The contribution of growth and risk variables was higher compared to interest rate variables. However, the influence of changes in the federal funds rate (FFR) appeared to have somewhat increased during the current tightening phase, which the BOK attributed to the rapid recent increases in the Fed’s policy rates.
Additionally, when comparing the influence of factors determining investment fund flows, Korea showed a greater impact from growth rate differentials and the volatility index (VIX) compared to the emerging market average, while the influence of interest rate variables was at a similar level.
Jo Yoo-jung, head of the International Finance Research Team at the BOK’s International Department, stated, "When analyzing the outlook and factors for emerging market investment fund flows, it is necessary to comprehensively consider various factors beyond the Fed’s monetary policy, including the pace of interest rate hikes and the monetary policy stance prior to the tightening phase. If the monetary policy tightening occurs faster than expected or follows a prolonged easing period, net capital outflows may occur, increasing volatility in the external sector."
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