Chapter

II Portfolio Capital Flows to the Developing Country Members of APEC

Author(s):
Carmen Reinhart, and Mohsin Khan
Published Date:
October 1995
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Author(s)
Shogo Ishii and Steven Dunaway 

Over the past five years, developing countries as a whole have experienced a strong increase in capital inflows, as many of these countries have implemented strong macroeconomic and structural reform programs and have resolved their debt problems. No other group of countries within this broad category has witnessed as large an increase in private capital inflows as the developing country members of the Asia-Pacific Economic Cooperation Council (APEC), and, indeed, inflows to this group have dominated developments in such flows to the developing world.

This section focuses on flows to the developing country members of APEC, analyzing recent trends and the composition and characteristics of international transactions in bonds and equities. It also presents some indications of the sources and destinations of these capital flows. However, serious data limitations limit the analysis. Balance of payments data are not available for Brunei and Hong Kong, with the lack of data for Hong Kong being especially important. Available balance of payments data also do not provide substantial details on the geographic origins and destinations of international capital transactions. Particularly in the case of portfolio capital flows, only limited data are available on bilateral transactions. An additional complication is the role played by international and regional financial centers as intermediaries in portfolio capital transactions, making it more difficult to track capital flows from their source to their ultimate destination. Information on types of portfolio transactions is also incomplete. While data on international placements of bond and equity issues are plentiful, only limited data are available on direct purchases by foreigners of securities on local financial markets. In addition, only partial information is available on the composition and characteristics of the investors in the securities of the APEC developing countries and on the recipients of this funding in these countries. Where gaps in the available information exist, partial or indicative data are used to illustrate developments and basic trends. All in all, there probably exist significant unrecorded capital flows.

Recent Experience

Following the onset of the debt crisis in 1982, medium- and long-term capital flows to developing countries as a group fell sharply, with net outflows taking place during 1987–88 (Chart 2-1).2 In 1990, the flows began to rebound strongly and have since risen rapidly, with the composition shifting substantially over the period. While syndicated bank loans had been the principal sources in the 1970s and early 1980s, foreign direct investment and portfolio capital flows have accounted for most of the inflows in the 1990s. The majority of these flows have gone to a relatively small number of countries concentrated in Asia and Latin America, most of them APEC members. In fact, the developing country members of APEC were the destination of a very high proportion of total medium- and long-term capital flows to developing countries during 1990–93 (Table 2-1 and Appendix Table 1; appendix tables begin on p. 58).

Chart 2-1.Capital Flows to Developing Countries1

(In billions of U.S. dollars)

Sources: IMF, Balance of Payments Statistics Yearbook (Washington, various issues); and IMF staff estimates.

1Net medium- and long-term capital, excluding exceptional financing and flows associated with debt- and debt-service reduction operations; Brunei and Hong Kong are not included owing to the unavailability of data.

Table 2-1.Capital Flows to Developing Countries1
Annual Average

1982–89
1990199119921993
(In billions of U.S. dollars)
All developing countries20.112.657.152.7104.8
APEC developing countries10.026.651.943.389.4
Asia10.213.029.823.657.6
NIEs2-1.7-5.05.17.38.7
Other11.917.924.716.348.9
Chile-0.90.80.50.81.5
Mexico0.712.821.618.930.3
Other developing countries15.0-14.05.29.415.4
(In percent of GDP)
All developing countries0.70.31.31.32.3
APEC developing countries1.21.93.42.54.6
Asia1.51.22.51.83.8
NIEs2-1.11.01.31.5
Other2.32.83.62.15.3
Chile-5.12.81.51.93.4
Mexico0.55.27.55.78.4
Other developing countries0.6-0.50.20.40.6
Sources: IMF, Balance of Payments Statistics Yearbook; and IMF staff estimates.

Net medium- and long-term capital, excluding exceptional financing and flows associated with debt- and debt-service-reduction operations; Brunei and Hong Kong are not included owing to the unavailability of data.

Korea, Singapore, and Taiwan Province of China.

Sources: IMF, Balance of Payments Statistics Yearbook; and IMF staff estimates.

Net medium- and long-term capital, excluding exceptional financing and flows associated with debt- and debt-service-reduction operations; Brunei and Hong Kong are not included owing to the unavailability of data.

Korea, Singapore, and Taiwan Province of China.

There was a slowdown in capital inflows in early 1994 following increases in U.S. interest rates beginning in February. Private financing for developing countries in the form of portfolio flows posted a steep drop. Even the developing country members of APEC with relatively good credit ratings experienced a tightening in the terms on new bond issues and significant declines in stock prices. Given the prevailing uncertainties, both issuers and investors in bonds and stocks pulled back and waited for the markets to settle. In May and June 1994, the return of some high-quality issuers to the markets indicated a modest recovery.

Composition and Geographic Distribution of Capital Flows

The rapid rise in medium- and long-term capital flows to APEC developing countries since the late 1980s primarily reflects the strong growth in foreign direct investment and a dramatic increase in portfolio capital inflows (Chart 2-2 and Table 2-2). Other capital flows (primarily bank lending) shifted from net outflows in the mid-1980s back to net inflows following the resolution of the debt problems of some APEC members in the late 1980s. Nonetheless, such flows have not been a consistent source of funding, partly reflecting the cautious attitude of commercial banks toward new lending to developing countries.

Chart 2-2.Composition of Capital Flows to APEC Developing Countries1

(In billions of US. dollars)

Sources: IMF, Balance of Payments Statistics Yearbook (Washington, various issues); and IMF staff estimates.

1Net medium- and long-term capital excluding exceptional financing and flows associated with debt- and debt-service-reduction operations; Brunei and Hong Kong are not included owing to the unavailability of data.

Table 2-2.Capital Flows to APEC Developing Countries1
Annual Average

1982–89
1990199119921993
(In billions of U.S. dollars)
Capital flows9.826.651.943.389.4
Foreign direct investment6.212.119.123.439.5
Portfolio investment0.90.511.519.937.1
Other2.714.121.312.8
(In percent)
Memorandum items:
Real GDP growth
All developing countries4.53.74.56.06.2
APEC developing countries6.65.77.08.78.9
Other developing countries3.22.42.53.73.8
Industrial countries3.02.40.71.51.3
Sources: IMF, Balance of Payments Statistics Yearbook; IMF, World Economic Outlook; and IMF staff estimates.

Net medium- and long-term capital excluding exceptional financing and flows associated with debt- and debt-service-reduction operations; Brunei and Hong Kong are not included owing to the unavailability of data.

Sources: IMF, Balance of Payments Statistics Yearbook; IMF, World Economic Outlook; and IMF staff estimates.

Net medium- and long-term capital excluding exceptional financing and flows associated with debt- and debt-service-reduction operations; Brunei and Hong Kong are not included owing to the unavailability of data.

The pattern of capital inflows to the different subgroups of APEC developing countries has varied significantly (Chart 2-3). Most of the inflows in recent years have gone to Mexico and to the Asian APEC members other than the newly industrializing economies (NIEs). For Mexico, this represents a sharp reversal of the experience during the 1980s, when debt difficulties were manifested in net capital outflows during most of the period after 1982. With the resolution of debt problems and restoration of confidence associated with the implementation of sound policies, Mexico has witnessed a dramatic rise in capital inflows during the 1990s. In contrast, the Asian members of APEC other than the NIEs received significant capital inflows throughout the 1980s, with a marked increase taking place in the early 1990s. Capital flows to the Asian NIEs generally declined over the 1980s and into the 1990s, as some of these countries have begun to provide funds, particularly to other countries in the region.

Chart 2-3.Capital Flows to APEC Developing Countries1

(In billions of U.S. dollars)

Sources: IMF, Balance of Payments Statistics Yearbook (Washington, various issues); and IMF staff estimates.

1Net medium- and long-term capital, excluding exceptional financing and flows associated with debt- and debt-service-reduction operations; Brunei and Hong Kong are not included owing to the unavailability of data.

Foreign direct investment has been a significant source of financing for APEC developing countries (Chart 2-4 and Appendix Table 2). Inflows to these countries grew in the second half of the 1980s and rose sharply in the early 1990s, as the non-NIE Asian countries implemented economic policies and structural reforms that led to an improved investment climate. Flows of foreign direct investment to China rose rapidly, along with a pickup in such flows to Indonesia, Malaysia, and Thailand. Mexico also experienced a rise in inflow of direct investment but to a lesser extent. In contrast, there have been only modest net inflows of foreign direct investment to the APEC NIEs as a group, largely owing to a shift to net outflows of direct investment capital in the 1990s from Taiwan Province of China, which has become an important source of foreign direct investment, especially for China.

Chart 2-4.Net Foreign Direct Investment in APEC Developing Countries1

(In billions of U.S. dollars)

Sources: IMF, Balance of Payments Statistics Yearbook (Washington, various issues); and IMF staff estimates.

1Brunei and Hong Kong are not included owing to the unavailability of data.

The most significant development in the 1990s, however, has been the growing importance of portfolio capital flows as a means of financing for the developing country members of APEC. Net portfolio capital inflows to these countries have increased from negligible levels during the 1980s (Chart 2-5 and Appendix Table 3) to account for a high and rising portion of total capital inflows during the 1990s. Among the developments that have made the climate for portfolio investment in these countries more attractive are improved foreign access to local financial markets, especially to stock markets, as well as improved availability and reliability of financial information on domestic firms.

Chart 2-5.Net Portfolio Capital Flows to APEC Developing Countries1

(In billions of US. dollars)

Sources: IMF, Balance of Payments Statistics Yearbook (Washington, various issues); and IMF staff estimates.

1Brunei and Hong Kong are not included owing to the unavailability of data.

Entities in these countries seeking to tap deeper pools of funds to meet their expanding capital needs for investment have also ventured into international financial markets. At the same time, international investors have shown greater interest in APEC developing countries. With the slowdown in economic activity in the industrial countries and the fall in interest rates worldwide in the early 1990s, developing country securities became more attractive owing to their higher returns. Lower international interest rates also reduced the debt-service burden of these countries and, hence, reduced default risk. Moreover, there appears to have been some reassessment of the riskiness of these securities, particularly for the APEC developing countries, owing in part to the solid macro-economic policy track records they have established and their generally strong economic performance over the period. Mexico has been the major recipient of portfolio capital inflows during the 1990s, accounting for about 60 percent of these flows to APEC developing countries. Nevertheless, Asian APEC members have also experienced substantial increases in portfolio inflows.

Recent Trends and Characteristics of Portfolio Capital Flows

International bond and equity placements have been a major avenue for portfolio flows to APEC developing countries, expanding noticeably in the early 1990s and reaching $39 billion in 1993 (Chart 2-6).3Both the investor base (especially with added institutional investor interest) and the range of borrowers with access to private market financing broadened considerably. By 1993, all of the larger developing country members of APEC were able to tap both international bond and equity markets. The increase in bond and equity flows to APEC developing countries was led principally by China, Indonesia, Malaysia, Mexico, the Philippines, and Thailand, reflecting investors’ recognition of the strength of economic policies and growth prospects in these countries. In the case of Mexico and the Philippines, the normalization of relations with private creditors following the completion of operations to reduce the two countries’ debt and debt service also played an important role. Asian APEC NIEs have maintained a presence in international bond and equity markets for many years and have stepped up placements of new issues in these markets in the early 1990s to exploit cheaper sources of funding brought about by the decline in international interest rates during this period. The decline in interest rates, along with strong economic policy performance in these countries, improved market perceptions of the creditworthiness of their securities, facilitating access to international financial markets. APEC developing countries’ access to international markets was also facilitated by regulatory changes in several creditor countries.4 Notably, the relaxation of restrictions on private placements in the United States improved access by developing country borrowers to this market.

Chart 2-6.International Bond and Equity Issues by APEC Developing Countries

(In billions of US. dollars)

Source: IMF staff estimates based on information from International Financing Review, EuroWeek, and Financial Times.

As noted above, conditions in international financial markets changed significantly in the first half of 1994 with the increases in U.S. interest rates. As a consequence, the volume of international bonds and equities issued by APEC developing countries as a group fell significantly between February and April 1994 from the record levels achieved in the final quarter of 1993. Nonetheless, the decline in placements by APEC developing countries was less steep than for other developing countries overall, owing to the fact that APEC members are generally viewed as being better credit risks. During this turbulent period in the financial markets, both issuers of securities and investors reduced their activities, waiting for conditions to settle. In May and June 1994, some recovery in placements took place, with higher-quality issuers, particularly APEC developing country members, returning to the markets. Despite these recent market developments, portfolio flows to APEC developing countries in the first half of 1994 were still significantly higher than the levels of the previous three years.

Bonds

In line with the recent trend in flows to other developing countries, the composition of private capital flows to APEC developing countries has shifted toward bond financing during the 1990s. International bonds issued by APEC developing countries increased from $4 billion in 1990 to $31 billion in 1993, partly in response to the decline in U.S. long-term interest rates and growing investor interest in these securities (Chart 2-7 and Appendix Table 4). Local stock market booms in Asian APEC members also made a major contribution to the increase in bond placements, as private firms in these countries expanded their access to funding and lowered their borrowing costs by issuing substantial amounts of bonds that could be converted into equities. Some APEC developing countries, including China and Mexico, issued sizable global bonds to tap several major international markets simultaneously. In so doing, they sought to attract broader demand and thus obtain more favorable terms than issuing in a single market. Bond placements by APEC developing countries reached a peak of $14 billion in the fourth quarter of 1993. Over the first half of 1994, new bond issues by these countries fell in response to overall developments in the market, but the share of APEC developing countries in total bonds issued internationally by developing countries rose.

Chart 2-7.International Bond Issues by APEC Developing Countries and U.S. Long-Term Interest Rates, 1990–Second Quarter 1994

Sources: IMF staff estimates based on information from International Financing Review, Euro Week, and financial Times; and IMF, International Financial Statistics (Washington, various issues).

Among APEC developing countries, Mexico has been the leading international bond issuer thus far in the 1990s (Appendix Table 5). Private firms accounted for the largest share of these issues, with the number of firms issuing and the size of issues expanding sharply in 1992 and 1993. Public sector corporations have also been major issuers, running only slightly behind private sector issues. Following a large issue in 1991, Mexican issues of sovereign bonds have declined in size and relative importance. Chile has not extensively tapped the international bond market since its return in 1991 with a sovereign issue. Another relatively small sovereign issue was placed in 1992, but, subsequently, only private Chilean firms have placed small issues internationally.

Hong Kong and Korea have been major issuers of bonds during the 1990s, placing the bulk of these issues in 1993. Bond placements by Hong Kong entities were entirely by private firms, while in the case of Korea, public sector entities accounted for a larger share than the private sector of the bonds placed. The private sector in Taiwan Province of China also placed substantial issues of new bonds in the first half of 1994.

The non-NIE Asian developing countries of APEC have also had a strong presence in the international bond markets in recent years, reflecting the return to the market of some of the major countries in this group after several years’ absence. Each of these countries returned to the market through an issue by a major public sector entity. China returned to international capital markets after a three-year absence with a Samurai bond issued by the China International Trust and Investment Corporation (CITIC) in October 1991, followed by additional large issues by public sector entities in 1992 and 1993.5 After a six-year absence, the Government of China also re-entered the market with three bond issues in 1993. The Philippines regained access to the international bond markets for the first time since the debt crisis of the 1980s, when the Government placed a bond issue in February 1993; other public sector entities and private firms were also able to gain access to the market during 1993. Malaysia’s return to the bond market in June 1993, after a four-year absence, was led by the state-owned petroleum company (Petronas). Private firms in Indonesia and Thailand were particularly large bond issuers in 1993 and in the first half of 1994.

Much of the borrowing by APEC developing countries through bonds so far has represented net capital inflows. Maturing bonds issued by these countries amounted to only $3 billion in 1990–93, compared with bond issues of $54 billion. As of the end of June 1994, the outstanding stock of international bonds issued by APEC developing countries was estimated to be $63 billion (about 53 percent of the total outstanding stock of international bonds issued by developing countries as a whole), with Asian members accounting for roughly 56 percent of the total APEC stock of bonds. Amortization payments on bonds issued by APEC developing countries are projected to rise significantly over the next few years, from about $2 billion in 1994 to a peak of $13 billion in 1998, as bullet repayments on bonds placed in the early 1990s fall due (Chart 2-8).6 Mexico, in particular, has large amounts of bonds maturing during this period.

Chart 2-8.Maturing Bonds of APEC Developing Countries

(In billions of U.S. dollars)

Source: IMF staff estimates based on information from International Financing Review, EuroWeek, and Financial Times.

The terms of new issues by APEC developing countries have improved significantly during the 1990s. The average yield spread at launch declined from 397 basis points in 1990 to 129 basis points in the first quarter of 1994, with the most notable improvement achieved by private sector issuers (Appendix Table 6).7 In the second quarter of 1994, unsettled conditions in the markets caused spreads to widen. Secondary market spreads for APEC developing country bonds generally followed a similar pattern. Terms on new issues by APEC developing countries have been better overall than those on bonds issued by other developing countries, with this difference being more pronounced for private sector borrowers than for public sector borrowers. During 1992–93, the average yield spread at launch for bonds issued by APEC developing countries was some 70 basis points lower than the corresponding average for all developing countries; this difference was about 90 basis points for private sector issuers.8 Within APEC developing countries, the Asian NIEs and other Asian countries, with the exception of the Philippines, commanded relatively low spreads, averaging 94 basis points and 135 basis points, respectively, in 1993. Chile and Mexico, both of which had experienced debt-servicing difficulties during the 1980s, paid higher spreads. Spreads at issue for Chilean bonds averaged less than 200 basis points. For Mexico, spreads have narrowed appreciably during the 1990s, falling from more than 350 basis points for public sector borrowers (more than 600 basis points for private sector borrowers) in 1990 to less than 200 basis points (around 350 basis points for private entities) in 1993.

The relatively favorable terms for APEC developing countries reflected the high credit ratings that have generally been assigned to them by major rating agencies. With the exception of Brunei and Papua New Guinea, all APEC developing countries have been assigned credit ratings; all rated countries, except Mexico and the Philippines, have received investment-grade ratings (Table 2-3).9 Outside of APEC, only a few developing countries have achieved an investment-grade rating from a major rating agency.

Table 2-3.Credit Ratings of APEC Developing Country Sovereign Borrowers1
Moody’s RatingS&P RatingRecent Changes
SingaporeAa2AA+Moody’s upgraded rating from Aa3 in May 1994.
Taiwan Province of ChinaAa3AA+Moody’s assigned an Aa3 rating in March 1994.
KoreaA1A+
ThailandA2A–
MalaysiaA2AMoody’s upgraded rating from A3 in March 1993.
Hong KongA3A
ChinaA3BBBSAP assigned its BBB rating in February 1992, while Moody’s assigned its rating A3 in September 1993.
ChileBaa2BBB+Moody’s assigned a Baa2 first-time investment rating in February 1994. S&P upgraded from BBB in December 1993.
IndonesiaBaa3BBB–S&P assigned first-time rating in July 1992.
MexicoBa2BB+S&P assigned first-time rating in July 1992.
(Par and discount bonds)Ba3BB+
PhilippinesBa3BB–First-time ratings assigned in July 1993.
Sources: Financial Times; International Financing Review, and Salomon Brothers.

Ranked in descending order according to rating. Ratings by Moody’s Investor Service and Standard and Poor’s. The ratings are ranked from highest to lowest as follows:

Sources: Financial Times; International Financing Review, and Salomon Brothers.

Ranked in descending order according to rating. Ratings by Moody’s Investor Service and Standard and Poor’s. The ratings are ranked from highest to lowest as follows:

Moody’sS&P
Investment gradeAaa, Aa, A, BaaAAA, AA+, AA, AA-, A+, A, A- BBB+, BBB, BBB-
Noninvestment gradeBa, BBB+, BB, BB-, B+, B, B-
Default gradeCaa, Ca, C, DCCC+, CCC, CCC-, CC, C
In addition, numbers from 1 (highest) to 3 are often attached to differentiate borrowers within a given grade.
In addition, numbers from 1 (highest) to 3 are often attached to differentiate borrowers within a given grade.

APEC developing countries have tended to issue bonds that include enhancement techniques (for example., early redemption (put) options or equity conversions),10 with a view to narrowing yield spreads at launch. Overall, 32 percent of total bond issues by APEC developing countries from 1990 through the first half of 1994 carried some form of enhancement (Appendix Table 7). In comparison, only 27 percent of all developing country bond issues carried enhancements during the same period. The pattern of enhancements has differed across countries and over time. During the early stages of regaining access to international financial markets, Mexican bond issues tended to feature the securitization of some type of revenue flow, such as export receipts, credit card receivables, and long distance telephone receipts. As Mexican entities established track records for timely payments on their bonds, this form of enhancement became less common. Issuers in Asian APEC developing countries have tended to use equity conversions and to a lesser extent put options. There was a noticeable shift to equity convertible options during the stock market booms in these countries. In the first half of 1994, turbulent market conditions led APEC developing countries to increase the use of techniques to enhance credit, particularly equity conversions and put options, with bonds carrying enhancements accounting for 59 percent of total issues.

Most bonds issued by APEC developing countries continue to be denominated in U.S. dollars because of the dominant size of this sector of the market and the strong interest of U.S. investors in the securities of these countries (Appendix Table 8). Yen-denominated bonds have accounted for a relatively small and slightly declining portion of total bond issues. Among the APEC developing countries, China has been the most active issuer of yen-denominated bonds, reflecting the considerable interest of Japanese investors in China.

In line with the experience of other developing countries, the majority of bond issues from the developing countries of APEC have been concentrated in the Eurobond market or through private placements, owing in part to less stringent disclosure standards. Mexican entities have issued the largest number of bonds outside the Euromarket, placing most of these issues in European currencies in local markets and some in the Samurai and Yankee markets. Borrowers in several Asian APEC developing countries, including China, Korea, and Malaysia, have also tapped the Samurai bond market. China, Indonesia, and Thailand have issued in the Yankee bond market as well.11 A few APEC developing country issuers, including China and Mexico, have also made placements in the Dragon bond market.12

In recent years, international investors have shown increasing interest in purchasing financial instruments denominated in local currency in domestic markets. Interest has been particularly strong in some of the Asian APEC members (such as Indonesia and the Philippines) and in Mexico. Because exchange rates in these countries are relatively stable, sizable differentials between domestic and international interest rates have attracted large capital inflows. Reliable data on these flows, however, are not available.13 Some indication of their potential magnitude is provided by the experience of Mexico, where foreign investors have been active purchasers of Mexican government treasury bills (Cetes and Tesobonos) and longer-term government paper (Ajustabonos). It is estimated that such investors now hold about 70 percent of outstanding Cetes and 55 percent of Ajustabonos.

Equities

Equity placements by APEC developing countries in international capital markets during the 1990s have been substantially smaller than bond issues but have nonetheless risen and represent a significant source of funding. These placements have grown steadily from $1.1 billion in 1990 to $8.1 billion in 1993 (Chart 2-9 and Appendix Table 9). As share prices in APEC developing countries fell sharply between February and April 1994, international equity placements by these countries declined from $4.5 billion in the final quarter of 1993 to $1.5 billion in the second quarter of 1994. Major equity issuers include China, Hong Kong, and Mexico, which together have accounted for 67 percent of the total international stock issues by APEC developing countries during the period 1990 through the second quarter of 1994.

Chart 2-9.International Equity Issues by APEC Developing Countries, 1990–Second Quarter 1994

(In billions of U.S. dollars)

Source: IMF staff estimates based on information from International Financing Review, EuroWeek, and Financial Times.

International equity placements have taken the form of American or global depository receipts (ADR/GDR) programs,14 international tranches of new placements in domestic stock markets, and issues in foreign stock markets. Mexican companies have placed equity issues internationally almost exclusively through ADR/GDR programs. In contrast, Asian APEC developing countries have used international tranches of domestic stock issues and direct issues in foreign markets as their principal means of placing equities abroad (Appendix Table 10). China has been the major issuer among these countries. It has issued few equities through ADR/GDR programs, focusing instead on listing selected Chinese enterprises on the Hong Kong Stock Exchange (HKSE) (so-called H-shares). Between July 1993 and May 1994, nine Chinese companies had been listed on the HKSE, raising about $1.5 billion, including a joint listing on the HKSE and the New York Stock Exchange (NYSE) for Shanghai Petrochemical Company.15 Two Chinese firms have also been listed on the Singapore Stock Exchange.

Over the last few years, direct equity purchases by international investors on local exchanges have become an increasingly important source of portfolio flows to APEC developing countries. Although comprehensive statistics on these transactions are not available, partial information suggests that such purchases have increased significantly, for instance, more than doubling in Mexico, to an estimated $10.7 billion in 1993. Such purchases in 1993 are reported to have amounted to $4.3 billion for Korea, $2 billion for Indonesia, and $1.4 billion for the Philippines. In China, foreign investment in B-shares (shares that are traded on domestic exchanges with ownership restricted to foreigners) is estimated to be on the order of $2 billion in the period 1992–June 1994.

Emerging market mutual funds have played a major role in channeling portfolio flows to developing countries during the last few years. These mutual funds in general have focused on equities, with the number of equity funds and their net assets growing significantly. Equity funds specifically targeting APEC developing countries numbered 231 by the end of 1993, and their total net asset value amounted to $17 billion (Appendix Table 11).16 It is estimated that net purchases of equities (including purchases of equities in international capital markets) through dedicated APEC developing country mutual funds averaged over $1 billion a year during 1990–93 (Appendix Table 12).17 This estimate probably significantly understates the flow to APEC developing countries because Asian and Latin American regional funds and global funds are not included. These funds could be expected to make substantial investments in APEC developing country equities; however, these data are not available. In total, net equity flows from global and regional funds averaged about $2 billion and $3 billion a year, respectively, during 1990–93.

Sources and Destinations of Portfolio Capital Flows

Comprehensive data on sources of portfolio capital flows are unavailable, and only fragmentary information exists regarding the investor base in developing country securities overall.18 Available information, however, gives a partial indication of the likely characteristics of investors in the securities of APEC developing countries.19

Investor Base

Asian countries that had maintained access to international markets continue to attract investments from mainstream institutional investors, especially in the United Kingdom and the United States. In contrast, Latin American countries probably experienced a significant reflow of flight capital as they begin to regain market access at the beginning of the 1990s. As noted above, the number of mutual funds dedicated to investing in developing country securities has also risen sharply. In 1992, the expansion in the investor base began to gain considerable momentum. Dedicated emerging market mutual funds continued to grow rapidly in terms of number and net asset value, while other mutual funds also began to purchase developing country securities. Reports suggest that some U.S. pension funds began to diversify their portfolios by holding these securities and that European institutional investors increased their holdings of these securities as well.

Investor preferences for developing country portfolio assets vary from country to country. U.S. investors play a major role in the market, largely focusing their purchases of debt and equity on issuers in Latin America and Asia. U.K. investors are also reported to be active in trading in developing country securities, tending to buy assets in Asia, and to a lesser extent, in Latin America. German investors are reported to be principally interested in issues by Eastern European countries but are beginning to show more interest in Latin American securities. Japanese investors have invested only a small share of their assets in developing country portfolio issues, mainly in the issues of Asian countries.

Recipients of Flows

Data on international bond and equity placements offer some indication of the major sectors of the economies of the APEC developing countries that have been the prime recipients of portfolio capital flows. Financial institutions have been the major issuers of international bonds in these countries. From 1990 through June 1994, financial institutions raised $28 billion, 40 percent of total international bond issues by APEC developing countries; commercial banks alone accounted for 33 percent of total issues (Appendix Table 13). The financial sector’s share was particularly high in China, Indonesia, Korea, Mexico, and Thailand. In China, financial institutions (including CITIC and the Bank of China) have, by government policy, acted as intermediaries (so-called windows) by borrowing abroad and then on-lending to domestic borrowers. In general, heavy international bond financing by financial institutions may raise important questions as to the capacity of the financial sector in a developing country to intermediate capital flows effectively and efficiently.20

In other sectors of APEC developing countries’ economies, nonsovereign borrowers that have successfully placed issues in international markets have tended to be well-established entities with large domestic market shares or strong export potential. From 1990 through June 1994, firms in the petroleum industry were large issuers in Malaysia and Mexico. Utilities accounted for a significant share of total bond placements by Korea, Malaysia, and the Philippines, and telecommunications companies accounted for a substantial share of issues by Chile and the Philippines. The electrical equipment and electronics industries were major bond issuers in Korea and Taiwan Province of China. The real estate sectors in Hong Kong and Thailand were very active in placing bonds abroad. Cement companies in Indonesia and Mexico and steel companies in Korea were important issuers. The broadest sectoral range of borrowers with access to international markets was achieved by Hong Kong, Korea, Mexico, and Thailand.

International equity placements by companies in APEC developing countries (Appendix Table 14) have been concentrated in telecommunications, banks and financial services, manufacturing, electronics, media, and steel. On an individual country basis, Mexican issuance has been dominated by the telecommunication sector (Telmex); in Hong Kong, by the financial sector; in Korea, by the electronics and shipping industries; and in China, by manufacturing firms. Privatization has played an important role in attracting equity investment from abroad, including Mexico’s Telmex ($1.9 billion), China Steel in Taiwan Province of China ($0.4 billion), and Singapore’s Telecome ($0.4 billion).

Portfolio Capital Flows Among APEC Countries

U.S. treasury data on transactions in foreign securities and Japan’s regional balance of payments statistics provide a partial picture of portfolio flows among APEC countries. According to U.S. treasury data, U.S. investors shifted from net sales (including transactions on local financial markets) of $3.5 billion of APEC developing country securities (stocks and bonds) in 1991 to net purchases of $8.5 billion in 1992 and $20.9 billion in 1993 (Appendix Tables 15 and 16). U.S. bond purchases were concentrated in Mexican issues; U.S. investors sold holdings of bonds issued by Asian APEC NIEs throughout the period. U.S. equity purchases were concentrated in the same countries, although sizable purchases of Mexican stocks also took place. The United States is estimated to have directly accounted for at least 43 percent of net portfolio flows to APEC developing countries in 1992 and 56 percent in 1993. These figures, however, probably understate U.S. purchases of these countries’ securities. The U.S. data show that net purchases of foreign securities from the United Kingdom reached nearly $55 billion in 1993, after averaging $26 billion a year in 1991–92. Major Eurobond dealers and a number of emerging markets mutual funds are located in London. Thus, it is likely that the ultimate destination of some significant portion of these portfolio flows to the United Kingdom included some of the developing country members of APEC.

By contrast, Japanese investors’ purchases of developing country securities have been relatively limited. Japan’s regional balance of payments statistics indicate that there were only small portfolio capital outflows directly from Japan to Southeast Asian countries and China during 1990–93 (Appendix Table 17).21 At the same time, investors from this region made substantial portfolio investments in Japan, particularly in 1991 during the boom in the Japanese stock market. These flows probably reflect transactions with financial centers such as Hong Kong and Singapore and with Taiwan Province of China.

Data on Samurai bond issuance draw a similar picture (Appendix Table 18). Samurai bonds are a principal means for developing countries to reach Japanese investors. While Samurai bond issuance by APEC developing countries has increased significantly in recent years, the total amount of bonds issued in 1990–93 was limited to about $4.4 billion (¥ 521 billion). China became the leading Samurai bond issuer among APEC developing countries in 1992–93. Of the other developing country members of APEC, only Hong Kong, Korea, Malaysia, and Mexico have placed bond issues in this market.

According to data from the Japan Securities Dealers Association (JSDA) on Japanese purchases of equities on local stock exchanges in Asian APEC developing countries, only minimal stock purchases were made during the period 1992 to August 1994, and total Japanese holdings of equities issued by entities in these countries are very small (Appendix Table 19). Japanese investors are permitted to buy or sell, through securities houses in Japan, foreign stocks listed on only those stock exchanges designated by the JSDA. The number of APEC developing country stock exchanges designated by the JSDA is currently nine, including Shanghai and Shenzhen, which were added in March-April 1994 (Appendix Table 20).22 No company from a developing country has had its stock listed on the Tokyo Stock Exchange—the only stock exchange in Japan on which foreign companies can be listed.23 Japanese investors have also invested in developing country equities through closed-end investment trusts listed on the Osaka Securities Exchange. At the end of August 1994, six trusts were listed, five of which were dedicated to APEC developing countries (Appendix Table 21); five more funds are expected to be established by the end of 1994, two of which are to be dedicated to Asian APEC developing countries. While the assets of existing funds targeting APEC developing countries have grown significantly within a short time, reflecting Japanese investors’ growing interest in Asian emerging markets, their net assets amounted to only $1.7 billion as of August 1994.

2These medium- and long-term flows include foreign direct investment, portfolio investment (bond and equity transactions), and other long-term capital flows to the private sector and to public sector enterprises. The distinction between portfolio equity flows and foreign direct investment equity flows is based on standard balance of payments accounting definitions. Foreign direct investment equity flows represent investments by residents of one country in the equities of a firm that is resident in another country, with the investors having the intention of exerting a direct influence on the operations of the firm. In the balance of payments accounts, this intention is defined in terms of a foreign resident acquiring a 10 percent or greater equity stake in a domestic firm.
3Data on international placements of bonds include issues by sovereign borrowers; these issues are identified separately in the tables.
4These changes are discussed more fully in Private Market Financing for Developing Countries, World Economic and Financial Surveys (Washington: International Monetary Fund, December 1993).
5A Samurai bond is a yen-denominated bond issued in Japan by a foreign borrower. For public placements, issuers are required to have an investment-grade credit rating.
6These estimates may vary somewhat depending on whether mar-ket conditions evolve such that bondholders decide to exercise early redemption options on some bonds.
7In this section, spreads refer to the difference between the yield on a bond of a developing country entity and the yield on an industrial country government bond denominated in the same currency and of comparable maturity. Yields on U.S. treasury securities and com-parable securities of other major industrial country governments are used as proxies for a risk-free return. Spreads are calculated only for bonds that do not include enhancements in their terms.
8These comparisons must be made carefully because the differences in yield spreads may reflect differences in the size of issues and their maturities, as well as differences in the credit quality of the issuers.
9Mexico has been assigned an investment-grade rating by one small U.S. agency, while the larger U.S. agencies have indicated periodically that consideration is being given to upgrading Mexico to investment grade.
10A bond with a put option grants the bondholder the right to sell the bond back to the issuer at par on a designated date. A convertible bond contains a provision that grants the bondholder the right to convert the bond to a predetermined number of shares of common stock in the issuing company.
11A Yankee bond is a U.S. dollar-denominated bond issued in the United States by a foreign borrower. Yankee issues are subject to U.S. Securities and Exchange Commission registration and disclosure requirements.
12A Dragon bond is a bond issued in the Asia-Pacific region outside of Japan in foreign currencies and listed on at least two securities exchanges in the region (mainly in Hong Kong, Singapore, and Taiwan Province of China).
13The World Bank is currently engaged in a project to develop an authoritative data base on portfolio capital flows directly into local bond and stock markets of developing countries by major recipient country. Among APEC members, Chile, Indonesia, Korea, Malaysia, Mexico, the Philippines, and Thailand are included in the project. Preliminary results of this study are expected to be available in early 1995.
14An ADR is a U.S. dollar-denominated equity-based instrument backed by shares in a foreign company held in trust. An ADR is traded like the underlying shares on major U.S. exchanges or in the over-the-counter market. The advantage of an ADR issue is that it allows companies in developing countries to broaden their investor base, while international investors can reduce their settlement and trading risks. A GDR is similar to an ADR but is issued and traded internationally.
15Previously, offshore special purpose entities affiliated with Chinese companies have been listed on the NYSE (e.g., Brilliance China Automobile, China Tire, and Ek Chor). Recently, additional Chinese firms have been listed on the NYSE.
16These funds usually hold about 10 percent of their portfolio in cash or other liquid industrial country assets. However, the data presented here may underestimate total mutual fund holdings of developing country assets because only those mutual funds that have invested more than 60 percent of their portfolio in emerging markets are included.
17An approximation for net purchases of APEC developing country equities by emerging market mutual funds can be obtained by adjusting the change in the funds’ net assets for share price increases.
18Work is currently being done by the IMF Committee on Balance of Payments Statistics to improve data on portfolio capital flows. A coordinated survey of portfolio investment data for 1997 will be conducted to provide additional information on the geographic distribution of industrial countries’ holdings of foreign securities and possibly information on other attributes of portfolio capital flows, such as their sources and destinations. It is hoped that, among APEC members, Australia, Canada, Japan, and the United Stales will participate in the study.
19A discussion of the investor base for developing country securities can be found in International Capital Markets: Developments, Prospects, and Policy Issues, World Economic and Financial Surveys (Washington: International Monetary Fund, 1994).
20The capacity of a developing country’s financial sector to intermediate capital flows is discussed in Section IV of this Occasional Paper.
21In Japan’s balance of payments data, Southeast Asia covers a broader range of countries than the APEC members in the region. Included are non-APEC member countries such as the Islamic State of Afghanistan, Bangladesh, Bhutan, India, Macao, Maldives, Myanmar, Nepal, Pakistan, and Sri Lanka. Actual portfolio capital flows from Japan to APEC developing countries are probably higher than the balance of payments data suggest, since some flows are recorded as going to third-country intermediaries (such as the United Kingdom and the United States) instead of to the ultimate destinations of these flows. The balance of payments data also understate flows because they do not reflect foreign security purchases that are not made through securities companies in Japan.
22Among APEC developing countries with existing local stock markets, only Chile and Taiwan Province of China are not included on the JSDA designation list. Outside the APEC developing countries, only one developing country stock exchange, the Buenos Aires Stock Exchange, is on this list.
23The number of foreign stocks listed on the Tokyo Stock Exchange has declined. Currently, 97 foreign companies are listed, compared with 127 at the end of 1991.

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