EM push & pull: As China rises, competition for capital heats up

China is set to attract more foreign capital, which could have big implications for investors in EM debt.

China’s economy dwarfs most of its emerging market peers, but it has not traditionally attracted foreign capital flows commensurate with its vast size. That may be about to change.

Two key drivers are leading China to hoover up more overseas capital. The first is its declining current account surplus. Morgan Stanley analysts forecast China will run a deficit this year, for the first time since 1993. 1 The government is loosening rules over foreign investment as it seeks to plug the gap.

The second driver is China’s inclusion in several global market indices. The weighting of Chinese A-shares in the MSCI EM equities index is rising and China is also on the brink of joining major fixed income benchmarks, potentially sparking outflows from other index constituents. The combined effect of these developments is likely to be increased competition for capital among smaller emerging economies dependent on foreign financing.

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