Markets in the Middle East and Central Asia could lose more because of their high sensitivity to global risks compared to other developing countries, according to a report by the International Monetary Fund (IMF), which highlighted the region’s increasing dependence on cash.
Capital flows to the region have almost doubled in the past decade, as governments suffering from low oil prices rushed to bond markets to finance their budget and reduce the current account deficit. Long-term FDI fell by almost half.
While funds have provided some governments with means to fill the deficit at “lower government and corporate transparency” makes them more sensitive to changes and risks from flows to other emerging markets, the IMF said.
“The global outlook is that of lower growth and rising uncertainty, including due to unresolved trade tensions,” the IMF said in the report released in Dubai on Monday. “Since inflows to the region are highly sensitive to changes in global uncertainty, there are risks of capital inflows falling or even reversing.”
These results increase the need to protect the region from global sales. The Washington-based IMF said efforts should focus on fiscal reform and support for foreign direct investment, whose decline was more pronounced in the Middle East and Central Asia than in the rest of the world because of weak growth prospects and political tensions.
The IMF said fiscal consolidation should continue. Interest rates should fall in countries where there is no inflationary pressure, and governments need to intervene to accumulate reserves, strengthen financial oversight and regulation, use macro-prudential tools to ensure financial stability for countries where flows are pressuring real exchange rates, and consider increasing exchange rate flexibility. According to the IMF, capital flows to the Middle East and Central Asia account for 20 per cent of the total in emerging markets, or 5 per cent before the global financial crisis. The Gulf states have increased global debt sales and have been able to list their bonds in emerging market indices at JPMorgan Chase & Co.
While these measures have helped to reduce borrowing costs, they have become a highlight of the region. One of the recommendations in the report is to focus on developing local financial markets, which vary widely in the region. The Gulf’s domestic bond markets are among the most prolific international borrowers in the developing world since the collapse of oil prices. Meanwhile, Egypt’s local currency bonds have delivered returns to investors of nearly 40% this year, the highest in the Bloomberg Barclays index.
Failure to act means the next crisis could hurt the entire region, the IMF said. The outlook therefore raises the urgent need for a comprehensive set of policies to stimulate FDI and mitigate the potential risks of disrupted capital flows.