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By Karin Strohecker
LONDON, Oct 1 (Reuters) - Net capital flows to emerging markets will be negative this year for the first time since 1988, with foreign investment halving from last year and heavy outflows from residents, the Institute of International Finance said on Thursday.
Foreign investment flows are expected to total $548 billion in 2015 compared to $1,074 billion last year, the IIF said in a report. That is equivalent to just 2 percent of developing countries' gross domestic product, down from a high of almost 8 percent in 2007, the global finance industry body said.
"(The) decline has been driven by a sustained slowdown in EM growth, and in particular by uncertainty about China's economy amid continuing concerns about the impact of the Fed's eventual turn to raise U.S. interest rates," the IIF said.
"(The) slowdown represents a marked intensification of trends that have been underway since 2012, making the current episode feel more like a lengthening drought rather than a crisis event."
Emerging markets are suffering heavy falls in stock, currency and bond markets. Investors have been fleeing equity and bond funds in droves while bricks-and-mortar foreign direct investment, or FDI, is shrinking as these economies slow.
Outflows from emerging stock and bond funds is approaching $100 billion, Bank of America Merrill Lynch said recently. But IIF data is broader in its scope, taking into account foreign direct investment, bank lending as well as portfolio flows.
The report is based on data from 30 emerging economies.
The IIF said that while flows into emerging markets were on the decline, outward-bound flows from citizens had accelerated and would hit $1.089 trillion this year. This ramps up the downward pressure on foreign currency reserves, exchange rates and asset prices across emerging markets, it added.
As a result net capital flows would amount to minus $540 billion this year, easing only moderately to $306 billion next year, the IIF calculated.
The outflows have put heavy pressure on emerging currencies, especially after China's mid-August decision to devalue the yuan. The IIF noted that currency weakness in several countries such as Brazil, Ukraine and Colombia now exceeded the 25 percent threshold that is used to identify an external crisis.
This in turn raises concerns about emerging companies that have borrowed heavily in hard currency during the cheap credit years following the 2008-2009 global crisis.
Non-financial emerging corporate debt stood at $27 trillion, having risen by the equivalent of 30 percent of GDP in the past five years, Hung Tran, the IIF's executive director, told reporters, calling the numbers "staggering".
"All the research shows that the speed of incurring the debt plays a key role in the quality of the debt and the likelihood of the crisis," Tran said.
He predicted, however, that a protracted growth slowdown was more likely than a sudden sharp meltdown because of relatively strong sovereign balance sheets, compared to prior crises.
Additional reporting by Sujata Rao; Editing by Catherine Evans