Capital Flows to Latin America: 2010 Overview and recent developments

Economic conditions were very supportive of capital flows to emerging markets in 2010 and are expected to remain favorable. According to the Institute of International Finance (IIF)'s estimates, net private capital inflows to emerging markets reached US$ 908 billion in 2010, 50% higher than in 2009. In Latin America, net private flows were US$ 220 billion in 2010, up from US$ 144 billion in 2009 and approaching 2007's record, with particular strength in corporate bonds. The IIF forecasts US$ 215 billion in flows to the region this year and US$ 216 billion for 2012. Capital flows were supported by strong fundamentals, long-term investor portfolio rebalancing - as emerging markets' weight in global equity and bond portfolios converges to their weight in the world economy - and abundant global liquidity, with the Fed's latest large-scale asset purchase program, in particular, contributing strongly to bolster liquidity

Latin American investors remain bullish on the region's outlook in 2011. However, they also see some external and domestic downside risks to the region's benign outlook. Global economic activity strengthened in the final months of 2010 and momentum is expected to continue in the first part of 2011. However, global uncertainty has again increased following the recent events in North Africa and the Middle East, with oil pressures clouding the economic outlook. Markets so far have kept their forecasts for global growth on a positive light, but the global economy faces the prospect of a bumpy ride if oil prices persist at current levels. According to Merrill Lynch, commodity price inflation is now rated as the largest "tail risk" by the participants on its global fund manager survey.

On the domestic side, the main challenge is coping with strong capital inflows and increasing inflationary pressures. Policymakers' ability to reduce spending and withdraw stimulus, as well as the timing and the pace at which monetary policy will be tightened as countries of the region begin to run out of excess capacity, are viewed as important sources of risk by investors.