(eToro Blog ) Capital is continuing to move into emerging market bond funds, reducing the cost of borrowing for developing countries and reducing the significance of the Western financial system. During the past eight consecutive weeks capital flows have taken the total invested in bond funds for 2011 to $7.9 billion dollars, according to EPFR, the fund data provider.

Capital flows into these funds have increased the price of the funds, which creates reduced yields on emerging market dollar-denominated sovereign and corporate debt to 5.48 per cent on average, from 6.14 per cent a year ago. Indonesia's fresh $2.5 billion bond, for example, yields 4.7 per cent, less than similar maturity euro-denominated debt of Italy and Spain.

Some emerging market countries are now judged to be less risky borrowers than several western European countries. The credit default swap index for 15 major emerging market countries, which measure the likelihood of a debt default in these countries has fallen by a third to 206, while the iTraxx SovX index for western European CDS has climbed to almost 190.

Local currency denominated bonds have proved particularly attractive as fund managers have sought additional returns through the appreciation of emerging market currencies. Robust inflows into emerging market bonds stand in contrast to nervousness over potentially overheating equity markets in developing countries, and the debt crisis in western Europe's periphery.

This selling has pushed MSCI's benchmark Emerging Markets index down 1 per cent so far this year, while bonds sold by governments and companies in developing countries have largely held firm. Although there is concern with regard to the decrease in yields in the EM space relative to safe havens such as the US and Germany, investor continue to chase yields generating a snowball effect.

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