The International Monetary Fund has cautioned that the ongoing conflict in the Middle East has become a "severe test" for the stability of emerging markets, reversing the trajectory of foreign capital flows. This warning comes amid heightened sensitivity among non-bank investors towards crises, exacerbating the flight of investments.
In an analytical chapter within the 2026 "Global Financial Stability Report," the Fund noted that the increasing reliance of emerging countries on "non-bank lenders" has intensified the impact of these shocks. This situation has made investment outflows faster and more severe compared to periods of traditional bank financing.
Details of the Situation
IMF President Kristalina Georgieva revealed in statements to Reuters that the war in the Middle East will lead to rising inflation and a slowdown in global growth. She added that the conflict has caused the worst disruption ever in global energy supplies, with millions of barrels of oil production halted due to the Iranian blockade of the Strait of Hormuz, a vital corridor for shipping one-fifth of the world's oil and gas production.
Even if the conflict is resolved quickly, the IMF is expected to downgrade its economic growth forecasts and raise its inflation projections. The report indicated that investment flows into emerging markets have surged by a staggering eightfold since the global financial crisis, reaching a cumulative value of around $4 trillion by 2025.
Background & Context
Debt is a primary driver in emerging markets, with portfolio debt obligations currently representing 15% of GDP, up from 9% in 2006. Non-bank investors, such as hedge funds and mutual funds, provide about 80% of this capital, a figure that has doubled compared to two decades ago.
The Fund's technical analysis illustrates how geopolitical tensions translate into financial outflows. When war risks rise, the global fear index (VIX) increases, leading to debt outflows equivalent to 1% of the quarterly GDP of emerging countries.
Impact & Consequences
Mutual funds and hedge funds are the most affected, experiencing a decline in their holdings of emerging market securities by up to 1.3% immediately following the shock. This is due to these funds' use of "leverage," forcing them to sell quickly to cover risk margins.
The Fund also warned of the danger of "index-based strategies," where passive funds automatically adjust their portfolios, leading to "simultaneous sell-offs" that exacerbate price declines. It also highlighted the "private credit" sector, which has grown fivefold to a size between $50 billion and $100 billion, complicating policymakers' ability to detect financial gaps before they explode.
Regional Significance
Amid the ongoing uncertainty caused by the war, the IMF urged governments in emerging markets to adopt defensive strategies that include strengthening financial margins. Countries with ample cash reserves and strong institutions are less affected by capital outflows.
Moreover, currencies should be allowed to move to absorb shocks, with limited interventions in the foreign exchange market when absolutely necessary. It is also crucial to simulate scenarios of severe economic shocks to ensure that financial institutions can withstand sudden halts in external financing.
In conclusion, the report indicates that current conditions require emerging countries to take proactive steps to protect their economies from the repercussions of regional conflicts, reflecting the importance of political and economic stability in fostering investor confidence.