Middle East and North Africa: Set for a Shift in Economic Policy

A Commentary by Masood Ahmed, Director, Middle East and Central Asia Department, International Monetary Fund

Published in International Economic Bulletin, Carnegie Endowment for International Peace, November, 2010

In line with the global rebound from the Great Recession, growth in most economies in the Middle East and North Africa (MENA) region is expected to accelerate in 2010 and 2011. Helped by rising oil prices and production levels, as well as supportive fiscal policies, output for the region is projected to expand by about 4.2 percent in 2010 and 4.8 percent in 2011—up from 2.3 percent in 2009. As a result, most countries can now focus on addressing the severe structural policy challenges that continue to cloud the economic horizon, such as long-standing, high unemployment rates and dependence on hydrocarbons.

Oil Exporters: Economic Growth Accelerates Markedly

Economic activity is bouncing back in the region’s oil-exporting countries—Algeria, Bahrain, Iran, Iraq, Kuwait, Libya, Oman, Qatar, Saudi Arabia, Sudan, the United Arab Emirates, and Yemen. With worldwide demand picking up, crude oil production is projected to grow from 24.5 million barrels per day (bpd) in 2009 to 25 million bpd in 2010 and 26 million bpd in 2011. Oil GDP, in turn, is expected to grow by 3.5 percent in 2010 and 4.3 percent in 2011.

Based on oil price projections of $76 per barrel in 2010 and $79 per barrel in 2011, the countries’ external balances are expected to turn around markedly. Exports are projected to increase by 19 percent in 2010, followed by a more moderate 10 percent increase in 2011, by which time they will have surpassed the $1 trillion mark. As a result, the combined current account surplus of these countries is projected to rise from $70 billion in 2009 to $120 billion in 2010 and $150 billion in 2011. The countries of the Gulf Cooperation Council (GCC) will account for close to $50 billion of this increase.

Non-oil growth, cushioned in 2009 by high levels of government spending, is projected to pick up by a more moderate 1 percentage point between 2009 and 2011. Non-oil-sector growth will continue to rely to some extent on supportive fiscal policy, given that private investment and credit remain sluggish and that capital inflows to the MENA region, unlike to some other regions, have resurged only slightly.

Although annual credit growth has picked up somewhat—rising from a low of just over 4 percent at the end of 2009 to around 7 percent in June 2010—it is nowhere near the 32 percent growth achieved right before the global financial crisis. The challenge for monetary policy will be to support credit growth while quelling the potential for inflation stemming from an increase in domestic activity and the lagged effect of rising international food prices.

The recovery in oil prices will allow fiscal balances to improve to varying degrees across the oil exporters. The improvement will be most notable in the GCC, where budget surpluses are expected to surge by almost 7 percentage points of GDP between 2009 and 2011. In countries that have ample fiscal space (particularly in the GCC and Algeria), but where private-sector activity is not yet sustaining itself and overheating has not begun, governments can continue to pursue expansionary fiscal policy through 2011. In countries where government budgets are under greater pressure, such as Iran, Sudan, and Yemen, the approach to fiscal policy will need to be more conservative.

Oil Importers: Growth Remains Too Slow to Tackle Unemployment

The region’s oil importers—Afghanistan, Djibouti, Egypt, Jordan, Lebanon, Mauritania, Morocco, Pakistan, Syria, and Tunisia—are seeing economic activity strengthen moderately in 2010, though there are a few exceptions, such as Pakistan, which experienced devastating floods earlier in the year. The group as a whole is slated to grow by 5 percent in 2010—a slight improvement from 4.6 percent in 2009, but not nearly enough to significantly curb the region’s high unemployment, which remains a major structural challenge.

IMF growth projections for the Middle East, North Africa, Afghanistan, and Pakistan (MENAP)

External receipts are again growing solidly in most countries: after declining sharply during the global crisis but rebounding in the aftermath, import and export growth had broadly stabilized by mid-2010. Workers’ remittances are also increasing steadily, with only Tunisia—which receives a large part of its remittances from Europe—projected to see lower inflows in 2010 than in 2009.

The oil importers have also remained resilient to the recent turbulence in global financial markets; private-sector credit is picking up—increasing at an annual rate of more than 10 percent in most countries—though banks in some countries still need to address elevated nonperforming loan ratios.

In light of stronger growth, the region’s governments are once again strengthening public finances. While public debt levels in most oil-importing countries are higher than the emerging-market average, improved fiscal positions in the years leading up to the global financial crisis gave room for the stimulus that limited the fallout in 2008–2009. With the resumption of fiscal consolidation, government deficits are projected to narrow in 2011 in most oil-importing countries.

Time to Focus on Medium-Term Structural Priorities

With economic recovery taking hold, the region is now well placed to refocus on medium-term challenges. For the oil exporters, reducing the dependence of government budgets and the economy on hydrocarbons should be the top priority. Countries should enact fiscal measures, such as rationalizing energy subsidies and diversifying the tax revenue base, to ensure the sustainable use of oil and gas revenues, as well as intergenerational equity.

The oil exporters should also take the opportunity to strengthen their financial sectors. Priorities will vary across countries, depending on the stage of banking development and the impact of the global financial crisis in each one, but reforms should focus on reducing the cyclical nature of bank lending, strengthening liquidity standards, addressing systematically important institutions, and improving bank resolution frameworks while creating conditions for more forceful and effective supervision.

For the GCC, the challenge is to consolidate gains made in the past, addressing any vulnerabilities uncovered by the crisis, and pursuing regulatory and supervisory reform in line with evolving international norms. Some other oil exporters in the region must remove entry and exit barriers, as well as reduce state ownership in the banking system to spur greater financial development.

Meanwhile, the region’s oil-importing countries must tackle unemployment. This will require faster, job-creating growth. As noted in the IMF’s October Regional Economic Outlook for the Middle East, these countries—which faced an average unemployment rate of 11 percent in 2008—will need to create 18.5 million full-time positions over the next decade if they are to absorb unemployed workers and new entrants to the labor force. If observed relationships between growth and employment trends in the region persist, countries will need to grow by 6.5 percent annually, on average, compared to the 4.5 percent average observed over the past decade.

To achieve this growth, countries must, first and foremost, boost their competitiveness. Sound macroeconomic policies—in particular, fiscal consolidation—will help, but governments will also need to make greater efforts to improve the business climate. Unfortunately, many of these countries are still characterized by burdensome regulatory systems, weak institutions, and a dominating public sector. Countries must also enhance labor market functioning by improving education (to better match the supply of, and demand for, certain skill sets) and ensuring that wages better reflect market conditions.

Finally, trade tariffs need to come down. While they have been streamlined and lowered—mainly under the auspices of trade agreements with the European Union and the United States—they remain high, averaging over 12 percent in 2009. Most importantly, with the region’s traditional advanced-economy trading partners now growing more slowly, MENA countries should seek new export markets and look to other, faster-growing emerging markets as partners along global supply chains. Tapping into those supply chains will also necessitate sophisticated transport, communications, and financial services development.