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LONDON, Jan 15 (Reuters) - Capital flows to emerging markets will decline in 2015 for the second year in a row due to the prospect of higher U.S. interest rates, a global finance industry body said on Thursday, predicting inflows of $1.06 trillion.
The Washington DC-based Institute of International Finance (IIF) said in a report that total private sector investment flows to emerging markets fell last year to $1.1 trillion, $250 billion less than the 2013 record high of $1.35 trillion.
Much of the decline was accounted for by a collapse in ows to Russia due to its conflict with Ukraine, but flows elsewhere were also affected by expectations of an impending interest rate rise by the U.S. Federal Reserve.
This year's outlook is clouded by the same factors, as well as by continued economic slowdown in China which took over half the 2014 inflows, the report said. But the Fed remains the main focus, outweighing policy easing in Japan and Europe.
"Shifting expectations about the timing and pace of the Fed policy rate hikes as well as uncertainty related to the oil market and political risk are likely to again deliver a bumpy ride during the year ahead," the IIF said.
The group said, however, that investors were increasingly differentiating between stronger and weaker emerging markets, and also pointed out that normally long-term institutional investors such as pension and sovereign funds accounted for most of the portfolio flow in 2014, providing crucial support to the sector.
It also expects 2016 flows to recover to $1.2 trillion, as markets adjust to the Fed policy shift, the Russia crisis eases and commodity prices stabilise.
But it warned: "Markets are pricing in only a limited amount of Fed tightening in the next two-three years -- and we see a significant likelihood that the Fed will need to raise rates more quickly than markets believe."
Despite an expected flows pickup next year, they will still fall short of 2013 peaks, the IIF forecast. They will equal 4 percent of annual emerging market gross domestic product (GDP), or half of 2007 levels, it added. (Editing by Mark Potter)