## 1. Net Capital Flows

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### Trends in Capital Inflows
- Oil exporters experienced a decline in inflows: bank flows and FDI fell from a 2003–08 average of 3.8 percent of GDP to an average of 2.6 percent of GDP a year since 2012.
- Oil importers’ inflows declined from 8.3 to 7.9 percent of GDP.
- Between 2016 and 2018, portfolio inflows to MENAP and the CCA accounted for about 20 percent of the total portfolio inflows to emerging market economies, up from 5 percent before the global financial crisis.
- Cumulative portfolio inflows in 2016–2018 reached $164 billion, of which nearly three-quarters went to Egypt, Oman, Qatar, and Saudi Arabia.
- Oil-exporting countries borrowed some $74 billion during 2018 through the first half of 2019, about 25 percent of total gross issuance during that period (market analysts).

### Composition and Concentration of Inflows
- Gross inflows are evenly split between oil importers and exporters and relatively concentrated: the top three countries in both groups account for slightly more than one-half of total flows.
- Composition shifted: FDI has fallen while portfolio and other (bank) inflows have risen.
- At least one-third of increased portfolio and bank inflows in 2018 went to the official sector, financing fiscal deficits in Egypt, Lebanon, Pakistan, and in oil exporters such as Bahrain and Oman.
- Nearly two-thirds of increased portfolio and bank inflows went to five countries: Lebanon, Morocco, Pakistan, Qatar, and Saudi Arabia.

### Role in Financing Fiscal and Current Account Needs
- Current account balances deteriorated especially strongly in oil importers: median deficit from 2010 to 2018 increased by 4.4 percentage points of GDP compared to 2000–09, owing to lower savings and higher investment.
- Fiscal balances worsened in oil exporters: the median postcrisis balance during 2009–18 deteriorated to a deficit of 0.1 percent of GDP, reflecting lower oil prices since 2014 and increased government spending.
- Portfolio inflows helped finance deficits in countries without large buffers (example: Egypt after exchange rate liberalization); inflows also helped Bahrain and Oman meet large government financing needs during fiscal consolidation.
- Countries with large buffers (Qatar, Saudi Arabia, United Arab Emirates) were able to borrow from international markets at relatively low rates without liquidating foreign assets.

### Risks from Reliance on Bank and Portfolio Inflows
- FDI has a higher growth impact than portfolio inflows; declining FDI reduces growth-enhancing capital.
- Portfolio inflows are almost twice as sensitive to changes in uncertainty in the region compared to other emerging market economies, reflecting lower government and corporate transparency.
- Rising bank and portfolio flows have increased private and public external indebtedness:
  - For oil-exporting countries, the GDP-weighted average of private external debt increased by 8.4 percent of GDP in the last four years.
  - The share of short-term external debt rose in some countries to 83 percent in Lebanon, 77 percent in Algeria, and 62 percent in Qatar.
- MENAP sovereign spreads tend to be higher than those of other emerging market economies of comparable ratings, reflecting elevated debt (Lebanon) and geopolitical instability.
- Given the global outlook of lower growth and rising uncertainty, inflows—being highly sensitive to global uncertainty—could fall or reverse, amplifying effects of oil price declines and placing buffers under pressure.

### Attracting Stable, Growth-Enhancing Capital Inflows
- FDI is driven more by domestic factors than global factors; slower growth and higher risks in the region explain about half of the postcrisis decline in FDI among oil exporters and 20 percent of the decline in oil importers.
- Key domestic gaps in determinants of FDI include control of corruption, human capital, and capital account restrictions, with larger gaps in oil-importing countries.
- Near-term policy measures to attract FDI:
  - Remove restrictions and increase investment opportunities (for example, opening up the services sector).
  - Recent steps include easing travel restrictions for foreign investors in Uzbekistan and allowing 100 percent foreign ownership in more sectors in several GCC countries.
- Long-term measures:
  - Improve education quality and increase median tertiary school enrollment to attract FDI to higher-value-added sectors.

### Mitigating Potential Risks from Volatile Inflows
- Priority: address large fiscal and current account deficits to reduce the risk of costly adjustments during a sudden stop.
- Macroeconomic policy measures recommended:
  - Continue fiscal consolidation.
  - Lower interest rates where inflationary pressures are absent.
  - Intervene to accumulate reserves where they are inadequate.
- Strengthen financial supervision and regulation, including on nonbank financial institutions, and utilize macroprudential tools to build resilience against volatile capital flows.
- Where inflows put pressure on real exchange rates, greater nominal exchange rate flexibility—supported by sound macroeconomic policies—can act as a shock absorber.
- Deepen domestic financial markets and enlarge domestic institutional investor bases to provide more stable funding (examples: Chile and Malaysia).
- Financial development in the region is below emerging market and advanced economy averages, with particularly large gaps in market liquidity and domestic institutional investor size.

### Financial market development and policy implications
- Developing regional financial markets (for example, the joint stock market in the Baltic countries) could help increase the investor base.
- Governments can foster financial market development by having a deep and liquid government bond market.
  - A government yield curve—established by gradual extension of government bond maturities and regular issuances at varying tenors—can serve as a benchmark for pricing of corporate bonds (see IMF 2013).
- The recent inclusion of GCC countries in the global sovereign bond index could help expand the investor pool and increase market liquidity.
  - Inclusion may raise market volatility since benchmark investors are more sensitive to global factors (Cerutti, Classens, and Puy 2015), as observed in recent emerging market outflow episodes (IMF 2019b), underscoring the need to expand the domestic investor base.
- Developing laws on the use of collateral could lower transaction costs and facilitate lending.

### Governance and legal environment
- The rule of law is a precondition to financial market development—stronger legal protection can encourage greater market participation, allowing for spontaneous and organic growth of financial markets (Chami, Fullenkamp, and Sharma 2009).
- Further strengthening legal systems, which lag behind peer averages (Figure 4.9), is crucial.
  - Recent efforts by Bahrain, Saudi Arabia, and the United Arab Emirates to modernize bankruptcy laws are welcome.
- Notes on indicators:
  - Use of indicators should be considered carefully, as they are derived from perceptions based data and estimates reflect relative and not absolute performance.
  - Confidence intervals are not available for the Strength of Legal Rights indicator.
  - Ranges are for 90 percent confidence interval, and confidence intervals for peer groups are negligible for Rule of Law.

### Institutional investor assets
- In GCC countries, domestic institutional investor assets—consisting of pension funds, mutual funds, and insurance companies—account for less than the half of GDP.
- In contrast, institutional investors’ assets exceed 100 percent of GDP in both Chile and Malaysia.

### Capital outflows from MENAP and the CCA
- Capital outflows from the Middle East, North Africa, Afghanistan, and Pakistan region and the Caucasus and Central Asia have declined since the mid-2000s.
- As oil prices fell, net purchases of foreign assets by oil exporters reached their minimum in 2015–16 owing to disposal of foreign assets by Algeria, Iraq, and Saudi Arabia.
  - In Algeria and Iraq, the decline was entirely due to a decline in official reserves, while in Saudi Arabia, other types of outflows offset an even larger decline in reserves.
- Since then, foreign asset purchases have recovered only tenuously, with oil exporters spending their oil revenues to service domestic needs.
- Oil importers have also significantly reduced their foreign asset acquisition, with the median falling from 3.6 percent of GDP in 2000–09 to 1.5 percent of GDP in 2010–18.
  - This trend was the result of nearly continuous reduction in foreign assets in Lebanon and more sporadic declines in, for example, Egypt and Pakistan, where domestic vulnerabilities have increased.
- Declining accumulation of foreign assets may increase vulnerabilities stemming from volatility of inflows, especially for oil importers where net foreign asset positions are negative.
- Figure 4.1.1. MCDOE: Net Capital Outflows (Percent of GDP) uses APSP oil price (right scale); APSP is the average of UK Brent, Dubai Fateh, and West Texas Intermediate crude oil prices. APSP measured in US dollars a barrel.

### Drivers of portfolio inflows—push factors
- A push-pull factor model on a panel of 11 MENAP and CCA countries and 29 other emerging market economies from 1990 to 2018 finds:
  - Portfolio inflows are driven mostly by global push factors—the Chicago Board Options Exchange Volatility Index (VIX) and real US interest rate (proxy for global financial conditions).
  - Portfolio inflows to the region are almost twice as sensitive to changes in global uncertainty as those in other countries.
    - Possible explanation: relatively weaker government and corporate transparency in the region, leading to larger outflows during crises (Gaston Gelos and Wei 2005).
  - Portfolio flows to the region depend on oil prices:
    - Higher oil prices increase portfolio inflows to the region, most likely by improving its risk profile.
    - Higher oil prices dampen the impact of global financial conditions—possibly because some capital inflows to MENAP and CCA countries are regional flows from oil-exporting countries, whose liquidity conditions are driven more by oil prices than US monetary policy (IMF 2017b).
    - Example: Coordinated Portfolio Investment Survey reveals that at least two-thirds of Bahrain’s portfolio liabilities are held in other Gulf Cooperation Council economies.

- Table 4.2.1. Impact of Push Factors on Portfolio Inflows/GDP, 1990–2018 (coefficients and standard errors)
  - Column (1) EMs
    - Log of VIX: –0.592 (0.319) *
    - Real US interest rate: –0.145 (0.051) ***
  - Column (2) MENAP and CCA
    - Log of VIX: –1.267 (0.518) **
    - Real US interest rate: –0.713 (0.528) ^
    - Log of real oil price: 0.765 (0.380) *
    - Log of VIX * MENAP dummy: –1.298 (0.698) *
    - Real US interest rate * MENAP dummy: 0.192 (0.072) **
    - Real US interest rate * log of real oil price: 0.211 (0.131) ^
  - Source notes:
    - All regressions include lagged real GDP growth, lagged composite risk index, global financial crisis dummies, and country fixed effects.
    - Robust standard errors clustered at country levels are reported in parentheses.
    - CCA = Caucasus and Central Asia; EMs = emerging market economies; MENAP = Middle East, North Africa, Afghanistan, and Pakistan; VIX = Chicago Board Options Exchange Volatility Index.
    - Significance: ***p , 0.01, **p , 0.05, *p , 0.1, ^p , 0.2.

*International Monetary Fund | October 2019 — Chapter 4 (Capital Flows to MENAP and the CCA).*

### 1. Net Capital Flows

### 1. Net Capital Flows

### Trends in Capital Inflows
- Oil exporters experienced a decline in inflows: bank flows and FDI fell from a 2003–08 average of 3.8 percent of GDP to an average of 2.6 percent of GDP a year since 2012.
- Oil importers’ inflows declined from 8.3 to 7.9 percent of GDP.
- Between 2016 and 2018, portfolio inflows to MENAP and the CCA accounted for about 20 percent of the total portfolio inflows to emerging market economies, up from 5 percent before the global financial crisis.
- Cumulative portfolio inflows in 2016–2018 reached $164 billion, of which nearly three-quarters went to Egypt, Oman, Qatar, and Saudi Arabia.
- Oil-exporting countries borrowed some $74 billion during 2018 through the first half of 2019, about 25 percent of total gross issuance during that period (market analysts).

### Composition and Concentration of Inflows
- Gross inflows are evenly split between oil importers and exporters and relatively concentrated: the top three countries in both groups account for slightly more than one-half of total flows.
- Composition shifted: FDI has fallen while portfolio and other (bank) inflows have risen.
- At least one-third of increased portfolio and bank inflows in 2018 went to the official sector, financing fiscal deficits in Egypt, Lebanon, Pakistan, and in oil exporters such as Bahrain and Oman.
- Nearly two-thirds of increased portfolio and bank inflows went to five countries: Lebanon, Morocco, Pakistan, Qatar, and Saudi Arabia.

### Role in Financing Fiscal and Current Account Needs
- Current account balances deteriorated especially strongly in oil importers: median deficit from 2010 to 2018 increased by 4.4 percentage points of GDP compared to 2000–09, owing to lower savings and higher investment.
- Fiscal balances worsened in oil exporters: the median postcrisis balance during 2009–18 deteriorated to a deficit of 0.1 percent of GDP, reflecting lower oil prices since 2014 and increased government spending.
- Portfolio inflows helped finance deficits in countries without large buffers (example: Egypt after exchange rate liberalization); inflows also helped Bahrain and Oman meet large government financing needs during fiscal consolidation.
- Countries with large buffers (Qatar, Saudi Arabia, United Arab Emirates) were able to borrow from international markets at relatively low rates without liquidating foreign assets.

### Risks from Reliance on Bank and Portfolio Inflows
- FDI has a higher growth impact than portfolio inflows; declining FDI reduces growth-enhancing capital.
- Portfolio inflows are almost twice as sensitive to changes in uncertainty in the region compared to other emerging market economies, reflecting lower government and corporate transparency.
- Rising bank and portfolio flows have increased private and public external indebtedness:
  - For oil-exporting countries, the GDP-weighted average of private external debt increased by 8.4 percent of GDP in the last four years.
  - The share of short-term external debt rose in some countries to 83 percent in Lebanon, 77 percent in Algeria, and 62 percent in Qatar.
- MENAP sovereign spreads tend to be higher than those of other emerging market economies of comparable ratings, reflecting elevated debt (Lebanon) and geopolitical instability.
- Given the global outlook of lower growth and rising uncertainty, inflows—being highly sensitive to global uncertainty—could fall or reverse, amplifying effects of oil price declines and placing buffers under pressure.

### Attracting Stable, Growth-Enhancing Capital Inflows
- FDI is driven more by domestic factors than global factors; slower growth and higher risks in the region explain about half of the postcrisis decline in FDI among oil exporters and 20 percent of the decline in oil importers.
- Key domestic gaps in determinants of FDI include control of corruption, human capital, and capital account restrictions, with larger gaps in oil-importing countries.
- Near-term policy measures to attract FDI:
  - Remove restrictions and increase investment opportunities (for example, opening up the services sector).
  - Recent steps include easing travel restrictions for foreign investors in Uzbekistan and allowing 100 percent foreign ownership in more sectors in several GCC countries.
- Long-term measures:
  - Improve education quality and increase median tertiary school enrollment to attract FDI to higher-value-added sectors.

### Mitigating Potential Risks from Volatile Inflows
- Priority: address large fiscal and current account deficits to reduce the risk of costly adjustments during a sudden stop.
- Macroeconomic policy measures recommended:
  - Continue fiscal consolidation.
  - Lower interest rates where inflationary pressures are absent.
  - Intervene to accumulate reserves where they are inadequate.
- Strengthen financial supervision and regulation, including on nonbank financial institutions, and utilize macroprudential tools to build resilience against volatile capital flows.
- Where inflows put pressure on real exchange rates, greater nominal exchange rate flexibility—supported by sound macroeconomic policies—can act as a shock absorber.
- Deepen domestic financial markets and enlarge domestic institutional investor bases to provide more stable funding (examples: Chile and Malaysia).
- Financial development in the region is below emerging market and advanced economy averages, with particularly large gaps in market liquidity and domestic institutional investor size.

*International Monetary Fund | Regional Economic Outlook: Middle East and Central Asia, October 2019 — Chapter 4 (Capital Flows to MENAP and the CCA).*

### 1. Financial Institution Depth, 2017

### 1. Financial Institution Depth, 2017

### Financial market development and policy implications
- Developing regional financial markets (for example, the joint stock market in the Baltic countries) could help increase the investor base.
- Governments can foster financial market development by having a deep and liquid government bond market.
  - A government yield curve—established by gradual extension of government bond maturities and regular issuances at varying tenors—can serve as a benchmark for pricing of corporate bonds (see IMF 2013).
- The recent inclusion of GCC countries in the global sovereign bond index could help expand the investor pool and increase market liquidity.
  - Inclusion may raise market volatility since benchmark investors are more sensitive to global factors (Cerutti, Classens, and Puy 2015), as observed in recent emerging market outflow episodes (IMF 2019b), underscoring the need to expand the domestic investor base.
- Developing laws on the use of collateral could lower transaction costs and facilitate lending.

### Governance and legal environment
- The rule of law is a precondition to financial market development—stronger legal protection can encourage greater market participation, allowing for spontaneous and organic growth of financial markets (Chami, Fullenkamp, and Sharma 2009).
- Further strengthening legal systems, which lag behind peer averages (Figure 4.9), is crucial.
  - Recent efforts by Bahrain, Saudi Arabia, and the United Arab Emirates to modernize bankruptcy laws are welcome.
- Notes on indicators:
  - Use of indicators should be considered carefully, as they are derived from perceptions based data and estimates reflect relative and not absolute performance.
  - Confidence intervals are not available for the Strength of Legal Rights indicator.
  - Ranges are for 90 percent confidence interval, and confidence intervals for peer groups are negligible for Rule of Law.

### Institutional investor assets (regional comparison)
- In GCC countries, domestic institutional investor assets—consisting of pension funds, mutual funds, and insurance companies—account for less than the half of GDP.
- In contrast, institutional investors’ assets exceed 100 percent of GDP in both Chile and Malaysia.

### Capital outflows from MENAP and the CCA (Box 4.1)
- Capital outflows from the Middle East, North Africa, Afghanistan, and Pakistan region and the Caucasus and Central Asia have declined since the mid-2000s.
- As oil prices fell, net purchases of foreign assets by oil exporters reached their minimum in 2015–16 owing to disposal of foreign assets by Algeria, Iraq, and Saudi Arabia.
  - In Algeria and Iraq, the decline was entirely due to a decline in official reserves, while in Saudi Arabia, other types of outflows offset an even larger decline in reserves.
- Since then, foreign asset purchases have recovered only tenuously, with oil exporters spending their oil revenues to service domestic needs.
- Oil importers have also significantly reduced their foreign asset acquisition, with the median falling from 3.6 percent of GDP in 2000–09 to 1.5 percent of GDP in 2010–18.
  - This trend was the result of nearly continuous reduction in foreign assets in Lebanon and more sporadic declines in, for example, Egypt and Pakistan, where domestic vulnerabilities have increased.
- Declining accumulation of foreign assets may increase vulnerabilities stemming from volatility of inflows, especially for oil importers where net foreign asset positions are negative.
- Figure 4.1.1. MCDOE: Net Capital Outflows (Percent of GDP) uses APSP oil price (right scale); APSP is the average of UK Brent, Dubai Fateh, and West Texas Intermediate crude oil prices. APSP measured in US dollars a barrel.

### Drivers of portfolio inflows—push factors (Box 4.2)
- A push-pull factor model on a panel of 11 MENAP and CCA countries and 29 other emerging market economies from 1990 to 2018 finds:
  - Portfolio inflows are driven mostly by global push factors—the Chicago Board Options Exchange Volatility Index (VIX) and real US interest rate (proxy for global financial conditions).
  - Portfolio inflows to the region are almost twice as sensitive to changes in global uncertainty as those in other countries.
    - Possible explanation: relatively weaker government and corporate transparency in the region, leading to larger outflows during crises (Gaston Gelos and Wei 2005).
  - Portfolio flows to the region depend on oil prices:
    - Higher oil prices increase portfolio inflows to the region, most likely by improving its risk profile.
    - Higher oil prices dampen the impact of global financial conditions—possibly because some capital inflows to MENAP and CCA countries are regional flows from oil-exporting countries, whose liquidity conditions are driven more by oil prices than US monetary policy (IMF 2017b).
    - Example: Coordinated Portfolio Investment Survey reveals that at least two-thirds of Bahrain’s portfolio liabilities are held in other Gulf Cooperation Council economies.

- Table 4.2.1. Impact of Push Factors on Portfolio Inflows/GDP, 1990–2018 (coefficients and standard errors)
  - Column (1) EMs
    - Log of VIX: –0.592 (0.319) *
    - Real US interest rate: –0.145 (0.051) ***
  - Column (2) MENAP and CCA
    - Log of VIX: –1.267 (0.518) **
    - Real US interest rate: –0.713 (0.528) ^
    - Log of real oil price: 0.765 (0.380) *
    - Log of VIX * MENAP dummy: –1.298 (0.698) *
    - Real US interest rate * MENAP dummy: 0.192 (0.072) **
    - Real US interest rate * log of real oil price: 0.211 (0.131) ^
  - Source notes:
    - All regressions include lagged real GDP growth, lagged composite risk index, global financial crisis dummies, and country fixed effects.
    - Robust standard errors clustered at country levels are reported in parentheses.
    - CCA = Caucasus and Central Asia; EMs = emerging market economies; MENAP = Middle East, North Africa, Afghanistan, and Pakistan; VIX = Chicago Board Options Exchange Volatility Index.
    - Significance: ***p , 0.01, **p , 0.05, *p , 0.1, ^p , 0.2.

*International Monetary Fund | October 2019*

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_Source: https://www.imf.org/-/media/files/publications/reo/mcd-cca/2019/october/english/menap-chapter4.pdf_