UAE seeks new controls on inflow of hot money

The Central Bank Governor has called for new restrictions to manage flows of so-called hot money into Arab economies. Greater supervision of the financial system could help to avoid the build up of such short-term speculative capital, said Sultan al Suwaidi. "Such money is harmful to our economies and we should put mitigants in its way to stop it," Mr al Suwaidi said during a speech in Abu Dhabi yesterday.

The UAE economy, which has few capital controls, remains at risk of a return of hot money as growth gains momentum. Renewed speculation about the dirham's peg to the US dollar could prove a magnet for inflows, they warn. Policymakers are anxious to avoid a repeat of 2007 when a flood of speculative money into the region stoked inflation and a housing bubble as investors brought in funds on the expectation that local currencies would be revalued.

The revaluation did not happen and the financial crisis sparked a sudden outflow of money, exacerbating a credit crunch in the UAE. Arab policymakers gathered in the capital yesterday for a conference jointly organised by the Arab Monetary Fund (AMF) and the World Bank to discuss how to boost inter-regional investment flows, while remaining vigilant about the pitfalls of hot money. Globally, capital flows to emerging markets are expected to rebound this year, rising by 34 per cent from last year to $710bn, according to figures from the Institute of International Finance.

"The global financial crisis highlighted the need for much greater regulation of investment flows," said Jassim al Mannai, the director general of the AMF and chairman of its board. Managing capital inflows remains a tricky task. Central banks have to find a way of discouraging short-term money while encouraging longer-term capital. "There's a trade-off," said Farouk Soussa, the chief economist for Citigroup in the Middle East.

"The more controls you introduce, the risk is the less attractive the destination for investment becomes." Among the options open to regulators is requiring a portion of inflows of short-term debt to be parked in a country's central bank for a certain period, such as six months, before it can be repatriated. A desire to head off such speculative investment has already prompted other emerging markets to consider imposing controls. India's government is weighing up the possibility of introducing limits on such capital, while Brazil last year introduced taxes on short-term debt.

An alternative to capital controls is applying measures to ensure long-term borrowing is matched with long-term lending. Hot money "is a fundamental issue and right now it makes sense to put together regulatory measures", said Mansoor Dailami, the manager of the development prospects group at the World Bank. "There is a need for the region to identify which sectors are potentially vulnerable to over-valuation like real estate and, instead, encourage investment in sectors that tend to be more sustainable, like agriculture or manufacturing."

Regulations on capital in the GCC remain relatively loose, while a review of local currencies' pegs to the dollar is likely to be a main driver of any future speculation, Mr Soussa said. [e-mail]