SeongJoon Cho | Bloomberg | Getty Images South Korea’s finance minister played down near-term risks of capital outflows from the Asian economy as gaps in global interest rates widen. Speaking to CNBC at the Group of 20 meeting in Bali, Choo Kyung-ho said that capital outflows from a country do not occur as a result of a single economic driver – such as interest rate gaps – as investors are also influenced by other factors such as the strength of an economy. Chu, who is also the country’s deputy prime minister, acknowledged that there are concerns that the US may be driven to more aggressive rate hikes and the widening of the interest rate spread could trigger capital outflows from South Korea. “The interest rate gap has happened in the past a few times, but we haven’t had significant capital outflows,” he said on Friday, as translated by CNBC. “Based on that, I think the capital outflow is not just happening because of an interest rate differential.” Capital outflows occur when assets and money leave one country for another because of better investment returns, such as higher interest rates. In June, the Federal Reserve raised benchmark interest rates by 75 basis points, its most aggressive rate hike since 1994. The U.S. Federal Reserve is poised to make another major rate hike at its upcoming meeting in July with some investors betting last week on a hike of up to 100 basis points after U.S. consumer inflation hit a 40-year high at 9, 1%.
The fundamentals are the basics
“The most important things are the fundamentals of an economy, if the economy can show credibility in the markets. Those are the factors that move capital,” Chu told CNBC’s Martin Sung. But South Korea’s finance minister said the Fed’s aggressive rate hikes – an effort to contain inflation – remained a cause for concern. The growing difference in borrowing costs between the US and South Korea could accelerate capital flows between the two countries down the road, he added. … I am not concerned about any dramatic capital outflow. Choo Kyung-ho Minister of Finance of South Korea Recent capital inflows into South Korea’s economy, particularly in the treasury markets, have also helped ease concerns about a capital flight, Choo added. “South Korea’s economy is experiencing less restraint compared to the global economy. And it’s still on a recovery path,” he said. “That’s why I’m not worried about any dramatic capital outflows.” Last week, the Bank of Korea acknowledged the risks of capital outflows when it marked a historic half-point interest rate hike in a bid to contain rising prices as inflation surged to its fastest pace in 24 years. Concerns about capital outflows, or capital flight, are starting to emerge as central banks around the world scramble to raise interest rates in an effort to curb rising inflation. The spread in interest rates between markets – especially with some markets like the US favoring more aggressive rate hikes – could start to lead to hot money flows as investors look for better returns. Past capital flight incidents include money movements reacting to US quantitative easing measures after the subprime crisis, which included increased liquidity and lower interest rates. The weakening US dollar forced funds into other markets, such as emerging economies in Asia, increasing inflationary pressures and appreciating currencies in those markets.
Hot money outflows in Asia?
Economists are beginning to warn about this round of hot money flows. Analysts at Mizuho Bank said in a note last week that there were concerns about capital outflows from India, particularly as the US actively raises interest rates and weaknesses emerge in India’s economy. India posted a record trade deficit of $25.6 billion in June as imports of crude oil and coal rose. “This will exacerbate volatile capital outflows, at a time when the US Fed has already committed to aggressive rate hikes, suggesting greater INR depreciation pressures,” analysts Vishnu Varathan, Lavanya Venkateswaran and Tan Boon Heng said.
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“The Reserve Bank of India, fully aware of this difficult situation, is preparing for further rate hikes.” Thailand may also consider more rate hikes to match the Fed’s rate hikes amid a devaluation of the Thai baht that “threatened to exacerbate imported inflation and exacerbate capital outflows in an adverse feedback loop,” analysts said. The Chinese economy could also face increased capital outflow pressures as a result of US interest rate hikes, although China’s own tacit economy was the most likely driver of money flows, said Larry Hu, chief economist at Macquarie Group on China, in a note last month.
