M. Stanley: emerging markets face capital flight risk

HONG KONG, Sept 26 (Reuters) -The bank industry panic that has devastated developed economies could cause capital inflows into emerging markets to fall by a quarter, increasing the risk of a global recession and even a currency crisis, Morgan Stanley strategists said on Friday.

Capital flows to emerging economies could drop to around $550 billion in 2009 from an estimated $730 billion this year, sapping a major source of growth in countries such as Brazil and China, Stephen Jen and Spyros Andreopoulos said in a note.

"A slowdown in the global economic growth rate will undermine capital flows into emerging markets. This, we believe, is a major risk to the emerging market currencies," they said.

Most of the capital that flows into emerging economies has been in the form of loans, not portfolio investments, which only make up 8 percent of the total.

Loans from banks and other institutions altogether make up 57 percent of total net private sector flows, while foreign direct investment accounts for 35 percent.

This means the shockwaves from Wall Street's implosion over the last few weeks that have accelerated a process of risk reduction and froze money markets will likely have a direct impact on emerging market capital inflows.

This will almost certainly hurt growth in emerging economies, one of the main drivers of global growth over the last year. This could slow growth in global gross domestic product below 3 percent -- a level the International Monetary Fund considers a recession.

Capital flows into emerging markets collapsed about a decade ago after the Asian currency crisis and Russian default. However, the damage to emerging markets could be greater this time because the sheer size of the capital flows has grown so much.

"As the global and emerging market economies slow into 2009, we believe that the risks are highly skewed for emerging market currency weakness. The risk of a crisis is still low, but rising, in our view," said Jen and Andreopoulos. (Reporting by Kevin Plumberg; Editing by Tomasz Janowski)