Capital Account Liberalization in the Southern Mediterranean

• Author: Saleh M. Nsouli and Mounir Rached
• Position: Deputy Director of the IMF Institute/Senior Economist in the Middle Eastern Division of the IMF Institute

The debate on capital mobility has intensified in the wake of East Asia's recent financial crisis, largely because of the risk of sudden reversals. The crisis demonstrates the importance of a strong macroeconomic stance, sound institutions, and an orderly sequencing of reforms to maximize the benefits and minimize the risks of capital account liberalization.

Over the past two decades, many countries in the developing world have benefited from relaxing restrictions on capital movements. In an increasingly globalized world, the Southern Mediterranean countries of Algeria, Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia, and Turkey could also reap considerable benefits from establishing full currency convertibility in an orderly manner.

A country is said to have achieved full convertibility of its currency when residents and nonresidents are allowed to convert the currency, at prevailing exchange rates, into foreign currencies and to use the latter freely for international transactions. Full capital account convertibility paves the way for a more efficient allocation of savings and increases a country's attractiveness to foreign investors. The elimination of controls on capital transactions gives businesses and individuals access to foreign financial markets and increases the funding available for trade and investment. In addition, cross-border competition widens the choice of risk-adjusted rates of return open to investors, provides opportunities for portfolio diversification, and encourages domestic financial markets to become more efficient.

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Net private capital inflows to the Southern Mediterranean countries have picked up in recent years, but they vary from country to country (Chart 1). Although many factors affect capital flows and growth, and it is difficult to establish causality, it is worth noting that Lebanon, which has virtually no exchange restrictions, has enjoyed massive net inflows, while Syria, the country with most restrictions, has received the smallest volume of inflows. Generally, the countries with the most exchange restrictions have had lower growth rates than those with more liberal exchange systems (Chart 2).

Exchange system restrictions

All the Southern Mediterranean countries listed above except Egypt (for technical reasons) and Syria have established current account convertibility by accepting the obligations under Article VIII of the IMF's Articles of Agreement. Egypt, Israel, Jordan, Lebanon, and Turkey have also achieved substantial capital account convertibility, while Algeria, Morocco, Syria, and Tunisia still have significant restrictions.

Except for Israel and Turkey, the countries in the first group above have virtually no restrictions on direct investment, while those in the second group regulate either inward or outward investment, or both. With regard to securities and money market instruments, fewer restrictions are imposed, in general, on inflows than on outflows, but the financial markets in most of the nine countries are not sufficiently developed to attract portfolio investment. Israel, Jordan, and Lebanon have the most liberal codes for capital and money market transactions, with no restrictions on either inflows or outflows. Although the other Southern Mediterranean countries generally do not prohibit foreign investment in domestic securities, they impose restrictions on outward flows, ranging from a requirement for prior approval to outright prohibition. Issuance of securities by nonresidents in domestic markets is unregulated in five countries (Egypt, Israel, Jordan, Lebanon, and Turkey), requires prior approval in Tunisia, and is prohibited in Syria. Only Tunisia regulates commercial borrowing from abroad, while Algeria, Lebanon, Syria, and Tunisia have restrictions on lending abroad. All the countries permit nonresidents to hold accounts in foreign and domestic currencies, but residents' accounts are subject to...