2. Finance

Financial integration is the process through which economic agents gain equal access to financial markets regionally or globally. Integrated financial markets provide participants with a single set of rules, equal access to financial instruments, and equal treatment within the market (Baele et al, 2004[1]). Features of financial integration include an increase in international financial flows, convergence of asset prices across countries and foreign penetration in the banking sector. International financial flows can take various forms. Capital flows typically refer to equity and debt flows for investment purposes, such as foreign direct investment (FDI), foreign portfolio investment and bank lending. Other types of international financial flows include remittances and official development assistance (ODA).

The process of financial integration is formally driven by the lifting of cross-border restrictions, such as restrictions on foreign investments, and by the harmonisation of financial regulations. The impact of financial integration has been extensively discussed in the economic literature. Empirical research suggests that integration has a positive impact on long-term growth – notably through larger, more efficient capital flows – but the relationship is not linear, and these benefits have been disputed to some degree (OECD, 2011[2]). Integration can increase the size of financial markets, allowing for economies of scale to develop; these are associated with lower costs, higher liquidity and risk-sharing through portfolio diversification (European Commission, 2018[3]). The reduction of costs and risks and the improved access to capital is beneficial for both investors and borrowers, and can facilitate a more productive allocation of investment capital by increasing investment opportunities. Lifting barriers to foreign investments allows both companies and investors to choose the most productive platforms and placements, and may lead to capital inflows to new markets. Recent evidence has highlighted the productivity benefits of FDI through technology transfers (Fons-Rosen et al, 2018[4]).

Financial institutions can benefit from integration by increasing the scale of their operations, leading to greater efficiency and profitability (African Development Bank, 2010[5]). In the banking sector, foreign penetration can improve the efficiency and quality of domestic banking-sector services through increased competition and knowledge transfer (Agénor, 2001[6]).

Since the 1990s, capital inflows to emerging economies, notably in East Asia and Latin America, have increased significantly both in volume and as a share of gross domestic product (GDP) (OECD, 2018[7]) (World Bank, 2014[8]). Through capital deepening and technological transfer, the rise in foreign capital has contributed to the growth potential of receiving countries. Greater access to affordable finance is especially beneficial in the case of small and medium-sized enterprises, which struggle the most in accessing capital.

The growing interconnectedness of financial markets can amplify the cross-border transmission of instability (OECD, 2012[9]). Research showed an association between capital flows, mainly portfolio and bank flows, and financial crises, in particular if liberalisation takes place before policy-related distortions have been removed and before domestic markets, institutions, and the administrative capacity of the prudential authorities have developed enough to generate confidence that foreign finance will be channelled in productive directions (Eichengreen, 2001[10]). Cases in point are the 1994 Mexican banking crisis, which followed the bank privatisation and financial liberalisation of the country (Graf, 1999[11]) and the 1990s banking crisis in Finland and other Nordic countries, where capital account liberalisation was accused of being one of its determinant factors (Herrala, 2020[12]). However, some cross-country empirical studies and studies that use measures of de facto integration or finer measures of de jure integration, were unable to find robust evidence that capital account liberalisation by itself increases vulnerability to financial crises (Kose et al, 2006[13]).

Political risks also challenge financial integration. For instance, North African economies saw an abrupt reversal of FDI flows as the 2008 financial crisis spread, and suffered additional pressures from the Arab Spring and the political uncertainty that ensued.

Large capital inflows resulting from financial integration can also affect a country’s current account balance. In Central Europe, in the years prior to the 2008 financial crisis, the surge of bank flows prompted a credit and asset price bubble that led to worsening deficits and debt (World Bank, 2014[8]). Large capital inflows do not automatically entail a worsening of the current account deficit, as this can be counteracted by other variables in the balance of payments, such as capital outflows (in the form of investments abroad by residents) or changes in foreign currency reserves. Countercyclical macroeconomic and prudential policies, when adequately conducted, can also help an economy avoid growing deficits or debts. This  emphasises the necessity to carefully prepare and monitor financial openness policies.

Other concerns are specific to the integration of the financial markets of emerging and developing economies with those of more-developed financial markets. As mentioned earlier, countries with less-developed capital markets can reap new investment opportunities from integrated markets (European Commission, 2018[14]). In studying the impact of financial development on investment capital allocation in countries with different levels of development from 1980 to 2014, Marconi and Upper (2017) found that less-developed financial systems allocate capital flows with less efficiency than developed ones. Furthermore, in contexts of low financial development, fast accumulation of capital (in other words, rapidly growing capital inflows) was found to worsen the allocative efficiency of the concerned systems.

In brief, liberalising financial markets in the absence of sound macro, prudential and regulatory policies may not evolve towards an optimal or efficient outcome (Baele et al, 2004[1]). Currently, financial integration and globalisation are moving at a much faster pace than global financial regulation and harmonisation. As national legislators remain the main actors in the crafting of domestic financial regulations, it is key that economies engage in the adoption of internationally set standards designed to foster the convergence of frameworks and to facilitate transparency.

There is no standard measure of financial integration across countries, although literature in this field often examines FDI flows. In the context of the UfM, the analysis focuses on three areas: i) indicators of financial development; ii) investment-related indicators; and iii) data on remittances, which constitute an important financial inflow in developing economies (their volume and frequency shed light on the availability and quality of infrastructures allowing remittances flows). Table 2.1 shows the six indicators examined in this chapter.

Official development assistance flows represent significant capital flows between UfM member states, notably from the European Union to Southern Mediterranean and Western Balkan countries. ODA flows can contribute to financial integration through the promotion of economic development (see Indicator F1 below), but they are not per se an indicator of financial development or integration, and were therefore not considered for the monitoring exercise.

In the 2018 European Financial Stability and Integration Review (European Commission, 2018[15]) the European Commission discussed the state of financial integration within the European Union, noting that developed markets may benefit more from a capital market union than less developed ones, typically in Central, Eastern and South Eastern Europe (CESEE) countries. The review underlined the importance of developing lagging local markets prior to the push for integration in a region with different levels of financial development.

Financial market development can be defined as the capacity of markets to perform efficiently as intermediators and stimulate growth through reduced information and transaction costs (Alomari et al, 2019[16]) (Creane et al, 2003[17]). It is driven by an increase in the demand of capital by companies and households and the supply of capital by investors, (European Commission, 2018[14]) as well as by macroeconomic stability through appropriate policies (Creane et al, 2003[17]).

In the UfM region, economies feature highly differing levels of economic and financial development. The MENA countries, the Western Balkans and the CESEE countries have lower levels of financial market depth and access than the other UfM member states, as measured by the Financial Development Index (IMF, 2020[18]).

There is considerable heterogeneity within sub-regions as well. Among the MENA countries, Egypt, Jordan and Morocco perform better in terms of financial access than other countries with similar (or higher, in the case of CESEE countries) income levels see also( Box 2.1).

In general, lagging countries perform better in access than in depth, reflecting their lower degree of integration into foreign, more developed markets, and their reliance on local markets.

The attractiveness of UfM economies to foreign investors depends on several factors, including market size and geography, but also the policies and institutions that support a coherent and predictable investment environment. For foreign investors, the rules governing their entry and operations in the host country are also important. Some legal or regulatory restrictions on FDI in general exist in most countries, either to protect specific domestic industries or for national security interests (OECD, 2021[21]).

The level of a country’s openness to foreign investment is reflected in the OECD FDI Regulatory Restrictiveness Index, which measures the restrictiveness of an economy’s rules on FDI (see Box 2.2). The Index provides an indication of a country’s investment climate, noting that a range of other factors come into play, including how FDI rules are implemented, the existence of state ownership in key sectors, the size of a country’s market and the extent of its integration with neighbours, and even geography. Used in combination with measures of other aspects relevant for the investment climate (e.g. good governance), the Index can help to explain variations among economies in attracting FDI.

For UfM countries that are members of the OECD, the source of information for measures to be scored under the FDI Index is the list of countries’ reservations under the OECD Code of Liberalisation of Capital Movements (Capital Movements Code) and its lists of exceptions and other measures reported for transparency under the National Treatment instrument1, as well as regular monitoring conducted by the OECD2. For non-OECD members, additional sources include information gathered through a review of relevant legislation, either in the context of OECD Investment Policy Reviews or specific projects (Kalinova et al., 2010[22]) (OECD, 2020[23]).

The Capital Movements Code provides a framework to ensure a country’s policy is not more restrictive than necessary, and remains to date the only multilateral instrument with the primary function of promoting transparency and openness of capital accounts. It covers a variety of transactions including direct investment, financial credits and loans, and operations in foreign exchange. It comprises a set of mutual rights and obligations established by governments (OECD, 2020[23]). Since 2012, it has been open for adherence by non-OECD member states. Countries that are not ready to undertake high openness commitments in a formal adherence process can still benefit from the Code’s framework and OECD’s expertise to improve their financial reform agenda (Blaschke, 2019[24]).

FDI regulatory restrictiveness varies greatly among UfM member states (Figure 2.3). Restrictiveness scores for 2019 show greater levels of openness in the Western Balkans and EU countries than among MENA countries. Virtually all MENA countries (except Morocco) are above the UfM average (0.075, on a scale from 0, open, to 1, closed), but the region converged towards the UfM average between 2010 and 2019, notably due to increased openness in Tunisia, Jordan and Egypt. Algeria and the Palestinian Authority are the two economies showing the highest levels of restrictions, with respective scores of 0.587 and 0.388, and in a specular way, they are the MENA economies with the lowest inflows of FDI (see in the following section (Figure 2.11). Morocco and Egypt, the two most open MENA economies, receive the largest inflows of FDI in the region.

The high scores of the most restrictive economies in the UfM are largely driven by restrictions applied on foreign equity ownership to all or most foreign investors, notably in MENA economies (Figure 2.4). MENA countries display an extensive list of restricted sectors, notably in non-oil manufacturing sectors and servicesFor instance, the Palestinian Authority prohibits majority foreign ownership across sectors with few exceptions (e.g. manufacturing, banking, hotels and restaurants). Similarly, until recently, Algeria restricted foreign ownership to less than 50% of a firm’s equity in all sectors; however, with the 2020 Finance Law the government lifted the cap on foreign ownership (OECD, 2021[25]).

Some countries have, indeed, made notable improvements. Jordan and Tunisia have recently carried out significant structural reforms concerning investment regulation, and show the greatest degrees of improvement between the base year and 2019.

The overall lower restrictiveness of Tunisian markets is a result of changes in screening and approval procedures, notably following the entry into force in April 2017 of Investment law No. 2016-71, which repealed the 1993 Investment Code, and Law No. 2019-47 for the improvement of the investment climate. Screening and approval procedures restrictiveness dropped from 0.073 in 2010 to 0.042 in 2019. Law No. 2016-71 removed the necessity for foreigners to obtain approval from the High Commission for investment in 46 sectors, and Law No. 2019-47 simplified enterprise creation and approval procedures for domestic and foreign investors.

In Jordan, throughout the 2012 to 2019 period, screening and approval procedures remained open, while all three other sub-indices improved. The Regulation for Organising non-Jordanian Investments No. 77 of 2016, which replaced regulation No. 47 of 2000, specifically lays out the framework for economic activities conducted in Jordan by non-Jordanians. Foreign equity restrictiveness dropped from 0.187 in the base year to 0.165 in 2019. While Article 4 broadened the scope of activities in which foreign investors can have a shareholding of up to 50%, Article 5 lowered the threshold of foreign ownership from 50% to 49% in certain activities, which likely has mitigated the improvement in this sub-index.

In terms of economic sectors, restrictions are concentrated in the primary and tertiary sectors, with the lowest degree of closeness being recorded in the secondary sector (Figure 2.5). This is consistent with global trends, where the manufacturing sector is consistently more open to FDI than other sectors (Mistura and Roulet, 2019[26]). In 2019, the average for the secondary sector for non-EU UfM member states was 0.087, compared to 0.168 for the primary sector and 0.193 for the tertiary sector. MENA countries, especially Tunisia and Jordan, show the greatest decrease in restrictions. Western Balkan countries perform similarly to the EU average overall, with the exception of Albania’s value for the primary sector.

An OECD survey of 60 developed and emerging economies showed that easing FDI restrictions has the most significant impact on the services sector as compared to manufacturing and agriculture (Mistura and Roulet, 2019[26]). As services tend to be the most restrictive sector in the UfM region, FDI liberalisation reforms oriented towards the tertiary industry may generate significant benefits in terms of bilateral stocks.

Restrictions on FDI can also affect the development of an economy’s financial sector. For instance, restrictions on foreign entry in the banking sector can influence the level of regionalisation or internationalisation of the sector. The average restriction index on the banking sectors only across the UfM region (0.029) is significantly lower than when all sectors are considered (Figure 2.6). With the exception of Algeria, Jordan and Tunisia, non-EU UfM member states are approximately equal to or below the region’s average. Given the relatively low levels of restrictions, there is potential for greater investments, which can spearhead the development of foreign bank entry in regions where it remains relatively constrained see (Box 2.3).

Exposing the banking sector to foreign investments can lead to several potential benefits. When the management of branches in a foreign market is closely linked to the parent bank, foreign entry can enhance local supervisory mechanisms (OECD, 2009[27]). The presence of foreign banks can facilitate access to foreign capital and to new financing opportunities. Foreign banks can in principle reduce cross-border capital flight in periods of instability, by allowing foreign investors to shift their capital from domestically owned bank to local foreign banks. A sound legal framework is a necessary precondition for the successful integration of foreign banks into domestic markets and for the optimisation of its benefits. This includes, but is not limited to, modernised legislation on bankruptcy, risk management, accounting, capital requirements, and lending. Countries have taken steps to implement international standards to varying degrees.

.

According to OECD research, liberalisation reforms can have a sizable and significant effect on FDI (OECD, 2021[25]). Overall, a 10% reduction in the level of FDI restrictiveness, as measured by the Index, could lead to a 2.1% increase in bilateral FDI inward stocks on average, all else held equal. If this average effect were to apply equally across all countries, the more restrictive economies could expect FDI stocks to be between 7 and 95% higher if they were to ease FDI restrictions to the OECD average level. While the magnitude of the impact of liberalisation reforms on FDI can vary between countries, it shows how restrictions still act as barriers to investment and that there is substantial room for FDI growth if governments continue to advance liberalisation reforms.

Finally, it is worth mentioning that FDI restrictions analysed in this section are discriminatory measures explicit in regulations or laws, but other de facto restrictions on foreign investors may exist (OECD, 2021[21]). These include institutional or informal barriers to investment (e.g. excessive bureaucracy or corruption), and also inconsistent enforcement of rules, distortions caused by state ownership in key sectors, special treatment received by certain firms, insufficient competition, skills shortages, inadequate infrastructure, political instability, governance challenges, and weak regional integration.

The distribution of FDI stock among UfM member states is considerably uneven (Figure 2.7). Also, within the UfM region, FDI flows usually involve an EU member state, whereas intra-MENA or intra-Western Balkans flows remain limited.

EU countries, especially, attract the overwhelming majority of investments due to the status as financial centres of some of the EU member states (Damgaard et al, 2019[28]). The relatively small share of investments distributed across MENA and Balkan countries reflects their low level of integration, coupled with existing restrictions to FDI in the regions. The predominance of the banking system, the limited development of financial systems, and external and internal shocks (such as financial crises) all constrain direct investment. Also, structural challenges shared by many MENA economies are hindering FDI (OECD, 2021[21]). These include insufficient competition, skills shortages, inadequate infrastructure, political instability, governance challenges, and weak regional integration.

On average, 68% of investment stock in a reporting economy from the UfM comes from another UfM member state. Given the depth of formal ties that EU member states share among themselves, they roughly have the highest share of intra-UfM investment. This is especially the case concerning smaller EU economies that have weaker financial ties with developed North American and Asian economies than countries like France and Germany. With the exception of Bosnia and Herzegovina and Lebanon, MENA and Western Balkan countries – in addition to Israel, Turkey and the United Kingdom – are below the average share of intra-UfM investment.

The MENA and Western Balkans regions are net receivers of foreign investments and have a limited presence as foreign investors (Figure 2.8). Lebanon is an exception, with USD  3.9  billion in outward stock against USD  2.9  billion in inward stock. In addition to structural long-term ties reflected by stocks, FDI flows reflect shorter-term changes in direct investment as influenced by global macroeconomic conditions and internal changes, including regulatory changes.

Investment outflows from the EU, whose member states are significant investors in the MENA and Western Balkans regions, follow global trends (Figure 2.9), namely a sharp decline following the 2007-08 financial crisis and progressive decline between 2016 and 2018, mainly due to a constriction of investment relations with the United States (European Commission, 2018[3]).

In the MENA region, following the 2008 financial crisis, the outbreak of political upheaval in several countries put pressure on the recovery of FDI, including on intra-regional investment (Box 2.4) (Figure 2.10). Egypt receives the largest amount of FDI (despite being among the most affected by the 2007-08 financial crisis and the Arab Spring), followed by Morocco.

Moving to other types of capital flows beyond FDI, this section analyses the level of openness to portfolio and bank cross-border flows. The capital restrictions index computed by (Schindler et al, 2015[31]) covers controls on inflows and outflows for ten types of assets, including money market, bonds and equities.

Restrictions on capital flows are heterogeneous in the UfM region (Figure 2.11). In particular

  • MENA economies implement more restrictions than the European average,

  • Algeria, Lebanon and Tunisia show the maximum level of overall inflow restrictiveness;

  • Egypt is open in the three categories on portfolio and financial credit capital inflows, while Morocco has some restrictions on equity and bond inflows.

With the exception of Lebanon and, to a lesser extent, Tunisia, most countries show greater degrees of restriction today than in 2007 (Figure 2.12). In Algeria, restrictions first increase in 2008 and follow a slow, fluctuating growth until 2013. But not all changes have been applied following the crisis across the region. In Israel and Turkey, the first restrictions appear in 2011, and the index continues to increase in 2012 and 2013. Lebanon experienced a slight decrease in 2016, highlighting a slightly more open market.

Along with FDI flows, portfolio flows provide information on the level of financial integration from the perspective of capital markets. Inward portfolio flows (liabilities) represent the volume of portfolio investment coming into the MENA and Western Balkan regions from the rest of the world. Outward portfolio flows (assets) represent the volume of portfolio investment from local investors into foreign economies.

With the exception of Turkey, which received significantly higher flows between 2009 and 2014, the focus economies have relatively low inflows, with generally limited fluctuations. Turkey, but also Egypt and Israel – the three economies showing the lowest levels of capital control (Indicator F4) within non-EU/UfM member states – seem to be the most affected by external and internal shocks, notably the 2007 financial crisis and the Arab Spring (Figure 2.4).

Similarly to FDI flows, MENA countries are much less present as global investors. Egypt, Israel and, to a lesser extent, Turkey show significantly greater volumes of portfolio capital outflows, with a high propensity to fluctuate Figure 2.14.

Aggregated inflows of MENA and Western Balkan economies show high heterogeneity from one year to another. The years following the financial crisis and the Arab Spring witnessed higher disinvestments than investments. The surge of inflows in 2017 is mostly captured by inflows to Egypt following an improved economic outlook and monetary and fiscal reform (World Bank, 2017[32]) (Figure 2.15).

Total portfolio outflows, after reaching a peak in 2010, experienced a downward trend, with a fluctuating volume of outflows ever since: they are in general negative, except for 2014 and 2018 where however outflows remain far from pre-2010 levels (Figure 2.16).

Remittances are money transfers between different parties, usually residing in different countries. Generally, a remittance refers to the sum of money sent by a migrant worker to family members in the worker’s country of origin. Remittances represent a significant source of external financing in low-to-middle–income economies, where such inflows can exceed FDI flows (IEMed, 2020[33]). In the UfM, 90% of emigrants from North Africa and almost all emigrants from the Western Balkans lived in an EU country in 2019. A sizable share of them migrated to seek employment opportunities, with their families continuing to live in their countries of origin (see Chapter 4).

Through the allocation of the migrant labour force in foreign, more productive markets, countries of origin capture gains they would not have access to otherwise. Remittance flows are the result of a cross-border reallocation of labour, and represent the regional distribution of gains generated in the remittance sending economy. There has been a significant increase in remittance flow since the 1980s. Inflows to developing countries represent a large source of income, often surpassing official development assistance (ODA). In 2016, the World Bank estimated that remittances reached USD 575 billion and involved 232 million migrants (World Bank, 2020[34]); see Box 2.5 for more information on the World Bank Remittance prices worldwide database.

Remittance flows indicate the volumes of financial transfers, while costs and efficiency provide insights into the structures allowing remittance flows and possible barriers to them. The World Bank estimates that reducing remittance costs by 5% could generate, at the world level, savings of up to USD 16 billion a year (World Bank, 2020[34]). Target 10.c of the UN Sustainable Development Goals specifically concerns the transaction costs of remittances: “by 2030, reduce to less than 3% the transaction costs of migrant remittances and eliminate remittance corridors with costs higher than 5%”.3

Several factors influence remittance prices, including the level of development of financial markets and institutions, low competition, statutory constraints, and constrained access to banks by remittance-sending migrants (World Bank, 2020[34]). Decision-making and cooperation at the national and regional levels can affect the volume of remittances going through formal challenges. Lowering transaction costs and strengthening the role of financial institutions in cross-border exchanges is an efficient way to capture remittances through formal channels. This can take the form of facilitation of foreign transactions through banks, reducing the fees of money transfer operators (MTOs), offering digital ways of transferring funds, etc. Furthermore, when domestic banks open borranches abroad, they provide remitters with lower transaction fees (World Bank, 2006[35]). Cost-efficient financial institutions operating at the regional level maximise the disposable income sent by remitters and encourage the use of formal transfer channels.

Remittance flows and costs are a relevant dimension of financial integration in the UfM region as they shed light on a form of capital exchange that is particularly significant between MENA and Balkan countries, on the one hand, and EU countries, Israel and Turkey on the other. While the volume of remittances is primarily determined by the presence of immigrants from a net remittance-receiving country in a net remittance-sending country, it also depends on the existence of financial structures allowing such transfer of money (i.e. MTOs) and on the costs imposed by such structures.

Remittances sent through formal channels can positively affect financial inclusion and literacy. Leveraging and maximising formal remittance flows can help lift migrant workers’ families out of poverty. Encouraging contact of remittance-receivers with banks and MTOs provides a first contact with financial institutions and promotes inclusion in the financial system. Empirical studies conducted in five Sub-Saharan countries (Burkina Faso, Kenya, Nigeria, Senegal and Uganda) found that receiving remittances increases the probability that migrant workers’ families subsequently open a bank account (Aga and Peria, 2014[36]).

Due to the Covid-19 pandemic, digital payments are expected to grow fast across the region in 2021 and beyond, which will require countries not only to develop the legal environment but also to strengthen the regulatory framework for service providers to allow for further innovation in this area. This would boost remittances as well as e-commerce, which is currently limited in part due to the lack of infrastructure for digital payments. In 2017, studies reported that only 8% of SMEs in the wider MENA region had an online presence (compared to 80% in the United States) and only 1.5% of the region’s retailers were online (McKenna, 2017[37]).

Key remittance corridors refer to the main source (or destination) of remittances for a country. UfM member countries from the MENA and Western Balkans regions are net remittance receivers, while Turkey and Israel are net remittance senders. Intra-UfM remittance flows are significant: 10 countries out of the 14 considered have at least one UfM member state as key partner. Based on available data, only Egypt is below the 5% target set by the United Nations – noting that the countries two key partners are not UfM member states. All other key corridors, notably ones with high UfM relevance, remain over the 5% threshold. Sending remittances to Tunisia, whose key partners are France and Italy, is the costliest transaction.

In several MENA and Balkan states, remittances represent a significant share of GDP (Table 2.3). On average, remittance inflows represent 10.4% of GDP in the Western Balkans and 7.8% in the MENA region against 0.8 in the EU. This percentage is likely underestimated in several countries due to remittance flows that are unaccounted for because they are sent through informal channels. In countries with significant inflows, the income generated through cutting transaction costs is significant both in absolute terms and as a share of GDP. This is the case with the Palestinian Authority, for instance, where remittances currently represent 17% of GDP.

Intra-UfM cooperation to reduce the costs of sending remittances would not only have a positive impact on the volume of remittances and on migrants’ families income, but would also promote financial literacy and financial inclusion, through greater contact with the banking sector and other financial institutions.

The countries of the UfM region vary considerably in their levels of financial development, and this can present a barrier to integrating the region’s financial sector. Cohesion in the degree of financial development and in the soundness and modernity of legal frameworks regulating cross-border financial relations (notably in MENA countries and the Western Balkans) is a prerequisite to promoting potential benefits and avoiding negative externalities from integration, including the spread of macroeconomic instability.

The frameworks regulating capital flows and the actual volume of flows are complementary indicators of the relative financial integration of a region. The bulk of capital exchange in the UfM region involves at least one EU member state.

In terms of cross-border restrictions on portfolio capital flows and investment flows, MENA markets are more restrictive than other UfM sub-regions. Restrictions on portfolio flows have tended to increase in the past decade, generally as a result of the financial crisis and the economic impact of the Arab Spring.

Levels of financial flows have remained relatively low in MENA and Western Balkan economies in the past decade. Turkey, Israel and to a lesser extent Egypt capture higher volumes of flows but are also more subject to external shocks.

Restrictions on foreign investment in the manufacturing and services sectors, notably concerning foreign ownership of equities, strongly account for these gaps – although recent reforms efforts are narrowing the gap, especially in Jordan and Tunisia. Further easing restrictions and facilitating investments in technology and science would allow for more technology transfers and linkages with local suppliers.

In terms of volume of direct investment, there is significant untapped potential for FDI within and between the MENA and Western Balkans sub-regions, which currently share limited FDI flows. Data on FDI flows and stocks in international databases is lacking for a number of countries in the UfM region, particularly in the MENA and Western Balkans sub-regions. It is recommended that countries report investment data so that the volume of financial flows can be properly estimated and monitored.

International organisations and frameworks like the OECD Codes of Liberalisation can provide guidance for gradually moving towards more openness and reaping the benefits of capital flows while ensuring resilience – in other words, for moving toward a ‘level playing field’ by raising the standards of financial systems such as capital requirements and loan and credit regulation.

Remittances represent a significant financial flow in the UfM region and an important source of income, notably in the MENA and Western Balkans regions. In some cases, there are few options for sending remittances through formal channels, and when such options exist, the associated costs can be prohibitive; as a result, it is estimated that a significant portion of remittances is sent through informal channels. International co-operation and public-private dialogue between UfM member states and the main remittance transfer institutions (including banks and MTOs) is necessary to promote the gathering of data on remittance costs and transfer efficiency, and to reduce avoidable costs.

Monitoring of financial flows globally and at the UfM level requires reliable and harmonised data collection. A greater engagement with international bodies, such as the OECD Investment Committee's Working Group on International Investment Statistics4, is highly recommended to enhance data availability and comparability.

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