Middle East War Triggers Capital Outflows! IMF Warns Emerging Markets Face a New Round of Shock

The International Monetary Fund (IMF), in a report, said that emerging market countries currently obtain foreign capital primarily through channels such as hedge funds, pension funds, and insurance companies, which makes them vulnerable to the risk of rapid capital outflows during crises.

The report shows that over the past 20 years, the share of funds flowing into emerging market debt from foreign securities investors has doubled to 80%. After the 2008 financial crisis, banks gradually reduced lending to emerging markets. Last year, about $4 trillion flowed into emerging markets from outside the regular banking system, including funds from hedge funds and various investment funds.

In the Global Financial Stability Report released on Tuesday, the IMF said that this kind of funding source “largely benefits emerging markets,” because ample global liquidity enables these countries to issue debt financing with longer maturities and lower costs.

However, the IMF also warned that since 2008, foreign investors have become more cautious, and when global financial conditions change, they are more likely to withdraw funds quickly.

The report said that countries and firms that rely on this type of funding source are “especially vulnerable to global financial shocks.”

The IMF also said that, compared with other foreign investors, hedge funds and investment funds are more sensitive to changes in risk; in emerging economies with shallower financial markets and limited policy and regulatory capacity, this risk will be amplified further.

“Sudden withdrawals of funds can intensify external financing pressure, increase borrowing costs, and trigger a significant depreciation of the exchange rate, thereby putting strain on the financial system and dragging down economic growth.”

The IMF warned that some countries are already experiencing these challenges: “With the outbreak of the war in the Middle East, these risks have come to the surface, and multiple emerging markets are undergoing a reversal in capital inflows from non-resident, non-bank investors.”

The IMF estimates that the size of emerging market external securities debt liabilities averages about 15% of gross domestic product (GDP). Equity liabilities from securities average about 7% of GDP, but in some emerging markets, this proportion accounts for a economically meaningful share of market capitalization in the stock market.

The report said that the holdings of foreign securities investors are especially large in certain countries’ currencies—for example, the Hungarian forint. Last year, a large influx of funds had pushed the forint up against the U.S. dollar by about 20%.

However, since the start of the Iran war at the end of February this year, the forint has weakened noticeably; after more than a year of strong performance beforehand, inflows to emerging markets declined.

The IMF also added that the scale of cross-border private credit and stablecoin inflows into emerging markets has also been “rapidly expanding,” with stablecoin flows closely tied to the trends in the cryptocurrency market.

To limit outflows of portfolio funds, the IMF urged countries to improve institutional quality, build better buffer mechanisms (such as foreign exchange reserves), and ensure that public debt is sustainable.

IMF Managing Director Kristalina Georgieva warned on Monday that, due to this Middle East conflict, all roads now lead to higher prices and slower growth. She added that, “Even if the war stops today, the negative impact on other parts of the world will persist.”

（Source: Caixin Global）