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Summary of "Analysis of developments in EU capital flows in the global context" (Bruegel, November 2018)

Core Content

This report provides an in-depth analysis of the developments in European Union (EU) capital flows within the broader global context, with a focus on the Capital Markets Union (CMU) as a key policy framework. It examines global and regional capital flows, exchange rate dynamics, and the role of equity financing in EU enterprises. The study highlights the persistence of global capital imbalances and their implications for the EU's financial integration and stability.

Main Points

Global Capital Flows and Imbalances

• Global Imbalances (2017): The patterns of global capital flows and imbalances, which had been established between 2013 and 2016, remained largely unchanged in 2017.
• Current Account Imbalances: The main current account surpluses are in the euro area and Japan, while the largest deficits are in the US, UK, Canada, and Australia.
• Stock Imbalances: The net international investment position (NIIP) reflects the same pattern, with advanced economies being net lenders and emerging economies net borrowers.
• Financial Account Balances: The EU as a whole remains a net exporter of capital, with significant outflows in portfolio investment and a decline in FDI.

Factors Influencing Capital Flows

• Monetary Policy Divergence: The US Federal Reserve began tightening monetary policy in 2015, while the European Central Bank (ECB) and Japan continued accommodative policies, leading to a shift in capital flows.
• Exchange Rates: The US dollar appreciated strongly in 2018, which contributed to the depreciation of emerging market currencies, reminiscent of the 2013 "taper tantrum."
• Commodity Prices: The rise in oil prices and the structural changes in China's economy played a role in altering capital flow patterns.
• Capital Controls: China implemented tighter capital controls in 2015 following a significant RMB depreciation, which was linked to the global policy environment and domestic economic conditions.

EU Capital Flows

• Euro Area as a Net Capital Exporter: Since 2013, the euro area has been the world's leading net exporter of capital, particularly in debt securities, especially to the US.
• FDI Trends: Gross FDI flows into and out of the euro area spiked in 2015 but declined in 2016–17, becoming negative in recent quarters, primarily due to movements between the euro area and the US.
• Intra-EU Flows: Intra-EU capital flows increased in late 2016 and early 2017 but weakened in the second half of 2017 and early 2018. These flows are largely driven by FDI and reflect the evolving economic dynamics within the EU.

Equity Financing in the EU

• Equity Finance as a Strategic Tool: The EU aims to promote external equity financing for firms as a way to reduce corporate sector debt levels and improve corporate governance and productivity.
• Equity Market Development: The share of listed equity in the balance sheets of EU non-financial enterprises has grown, but this is concentrated in the core euro area and large firms.
• Private Equity Growth: Private equity has expanded rapidly in the EU, with financing levels returning to pre-crisis levels by 2017. However, access to private equity is still limited to a small number of countries and firms.
• Firm-Level Data: Less than 4% of EU firms use external equity financing in any given half-year period. SMEs and firms in Central and Eastern Europe (CEE) and post-crisis euro-area countries face greater challenges in accessing equity financing.

Policy and Market Considerations

• Home Bias: Despite some improvements, the EU still shows a strong home bias in private equity investments. Fundraising and divestment outside the home country remain limited.
• UK as a Key Equity Market: The UK, as the most advanced equity market in Europe, continues to attract a large share of European investors. Its exit from the EU may reduce its role, necessitating greater integration of private equity flows within the EU27.
• Capital Market Integration: Regulatory reforms and capital market integration are critical for improving access to external equity financing and reducing macroeconomic vulnerabilities.

Key Information

• Global Trends: Advanced economies remain net lenders, while emerging economies are net borrowers. The US has become a major recipient of capital inflows, especially in the form of portfolio investment.
• China's Capital Flows: China's capital outflows decreased in 2017, and the RMB appreciated until mid-2018, though this was reversed in late 2018 due to trade tensions and exchange rate movements.
• EU's Financial Position: The EU continues to be a net capital exporter, with the financial account balance remaining in surplus. However, the composition of these flows has changed, with FDI playing a smaller role.
• Equity Finance Challenges: Despite the potential benefits of equity financing, access remains limited, particularly for SMEs and in CEE and post-crisis countries. This is due to both structural and policy-related constraints.

Conclusion

The report underscores the importance of capital market integration and regulatory reform in enhancing the availability of external equity financing for EU enterprises. It highlights the persistent macroeconomic vulnerabilities stemming from high corporate debt levels and the need for policy improvements in corporate governance and labor market flexibility. While the EU remains a net capital exporter, the evolving global monetary policy environment and exchange rate dynamics pose risks to financial stability and capital flows. The role of private equity in financing firms, particularly SMEs, is still limited and requires further development to align with growing financing needs.