Asian controls push capital to Gulf

Investors could turn to region to avoid restrictions.

Controls on capital flows into emerging markets such as China and India could encourage foreign investors to consider moving their money to the Gulf, where no similar restrictions exist, say analysts. Gulf markets have largely been overlooked in a resurgence in equity market risk-taking since last year. A decline in property prices combined with debt troubles at regional companies such as Dubai World, and the Saad Group and Ahmad Hamad Al Gosaibi and Brothers, has knocked confidence in regional debt and equity markets.

In contrast, concern is mounting that the combination of low interest rates and capital flows seeking high returns may lead to another build-up of asset price bubbles in China and India, primarily in property. The IMF last month suggested that Asian countries might have to impose capital controls on inflows to avoid their economies overheating. India's government has already weighed up the possibility of imposing controls to head off an influx of hot money.

"The imposition of capital controls could help to move interest from fast-growing Asia to Gulf markets, where equity values are relatively low and where no such controls exist," said Mark McFarland, an emerging markets economist at Emirates NBD. "This region has lagged [behind] emerging markets and there is potential for significant catch-up, in which capital flows can play a significant role." Capital flows to emerging markets are expected to rebound this year, rising by 34 per cent to US$710 billion (Dh2.6 trillion), according to figures from the Institute of International Finance. Of this, the MENA region's share is expected to form only 9 per cent.

Huge inflows of speculative money to the Gulf stoked high inflation and a housing bubble in 2008 as investors brought in funds in the expectation that local currencies would be revalued. The revaluation did not happen and the financial crisis sparked a sudden outflow of an estimated Dh180bn from the UAE, leaving the local economy cash-starved. Despite this, regulations on capital inflows in the region remain loose, with hedging against oil prices and a revaluation of GCC currencies likely to be the main drivers of any future build-up of speculative money flows.

Capital inflows to emerging economies have already led Brazil and Taiwan to impose capital controls. Brazil last year introduced taxes on short-term debt. Another option is to require a portion of inflows of short-term debt to be parked in the central bank for a certain period. The intention of these usually temporary measures is to filter inflows of hot money that can lead to an appreciation of exchange rates and unsustainable asset price rises, endangering financial stability.

"The Gulf region prides itself on being open to capital flows," said John Sfakianakis, the chief economist of Banque Saudi Fransi. "If China and India did put capital restrictions in place, some more money may come into the Gulf but I would not exaggerate the extent of that." Controls on capital flows could deter Gulf investors from pouring money into foreign emerging markets, said Robert McKinnon, the chief investment officer at ASAS Capital.

"Investors from the Gulf are starting to revert back to the cycle of investing outside the region again," Mr McKinnon said. "But anything that could restrict that investment flow again may mean they consider investing in the region." [e-mail]