Capital inflows may have a negative long run impact on financial stability
It is better to stay away from debt inflows as they might have a negative effect on financial stability
In line with its continuous efforts to support the decision-making process in the Arab countries, the Arab Monetary Fund (AMF) has released a study titled “Implications of Capital Inflows on financial stability in Arab countries”. This study sheds the light on the effect of capital inflows, whether it is direct investment or portfolio investment or other investments, on financial stability on a set of Arab countries and provides analytical framework for Arab countries that help them in improving their efforts in enhancing financial stability.
In this context, paper investigates the impact of net capital inflows on credit to the private sector as a share of gross domestic product. It tries to assess to what extent net capital inflows could lead to excessive credit growth and, hence, undermine financial stability. The results show that net capital inflows may have a negative long run impact on financial stability in the Arab countries through increasing credit growth.
A further analysis was made to examine the impact of each type of capital inflow on credit to the private sector in the selected countries. The results revealed that direct investment and portfolio investment have insignificant effect on credit to the private sector in the long-run, and therefore there are no fears of accumulating risks on the financial sector and, consequently, financial stability. Regarding other investments, the results showed a long-run positive effect on credit to the private sector in the selected countries. These results suggest that the evolution of other investments may have a negative long run impact on the financial stability in Arab countries.
The paper recommends the selected countries to focus more on direct investment and portfolio “equity” investment, as they do not have negative consequences on financial stability. Such investments do not have debt burden, and do not have adverse economic and financial effects such as speculative investments (hot money).
The full version of the study is available under this link.