## _mcd1603

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### Preface and scope
- Prepared by the IMF’s Middle East and Central Asia Department under the general guidance of Masood Ahmed.
- Project directed by Aasim M. Husain; led by Martin Sommer. Contributors: Greg Auclair, Armand Fouejieu, Inutu Lukonga, Saad Quayyum, Amir Sadeghi, Gazi Shbaikat, Andrew Tiffin, Juan Trevino, and Bruno Versailles. Neil Hickey provided editorial support; Joe Procopio managed production. Hanan Altimimi Bane assisted with formatting and Esther George provided additional support.
- Report is generally based on information as of April 2016.
- Macroeconomic assumptions and oil prices are consistent with the April 2016 World Economic Outlook:
  - Average Brent oil price assumed at $36 a barrel in 2016.
  - Average Brent oil price assumed at $42 a barrel in 2017.
  - Brent oil price assumed to gradually increase to $51 a barrel in 2021.
- Geographic focus: Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates), Algeria, and oil exporters in the Caucasus and Central Asia (Azerbaijan, Kazakhstan, Turkmenistan, and Uzbekistan).
- Exclusions: MENA oil exporters primarily driven by conflicts (Iraq, Libya, and Yemen) or by the removal of sanctions (Iran) are not covered.
- Terminology: The word oil is used interchangeably for both crude oil and natural gas.

### Major challenges and near-term outlook
- Lower oil prices have reduced growth, opened up large budget and trade deficits, and increased financial stability risks.
- The proliferation of conflicts in the MENA region continues to cause severe economic damage and significant spillovers.
- In the Caucasus and Central Asia (CCA), the adverse impact of lower oil prices has been compounded by slowdowns in Russia and China.
- Most MENA and CCA oil exporters have large financial buffers built up during the years of high oil prices that "can be drawn down in the coming years to smooth out—but not avoid—the adjustment to lower oil revenues."

### Oil dependence and price prospects
- Growth averages over the past 15 years:
  - almost 5 percent in the GCC region and Algeria,
  - more than 8 percent in CCA oil-exporting countries,
  - compared with 6 percent growth in all emerging markets and developing countries (EMDCs).
- Oil prices have plunged by some 60 percent since the middle of 2014.
- Hydrocarbon budget receipts are projected to have been reduced by more than 10 percent of GDP in all GCC countries, Algeria, and Azerbaijan over the past two years.
- Futures markets predict a modest recovery: from about $45 a barrel at present to about $50–$55 a barrel by the end of this decade, with unusually large uncertainty around that prediction.
- Projected changes in export values:
  - The value of oil and natural gas exports is projected to fall by almost $450 billion in the GCC countries and Algeria in 2016 compared with 2014.
  - The corresponding estimate for the CCA oil exporters is $65 billion.
  - The MENA and CCA oil importers are collectively projected to save only $20 billion on oil and gas imports this year compared with 2014.

### Fiscal challenges, policy responses, and required consolidation
- Initial responses:
  - GCC countries and Algeria have drawn down reserves and sovereign wealth fund assets; most have started to rein in budget spending.
  - CCA countries used exchange rate depreciation to facilitate adjustment; some managed currencies tightly (Turkmenistan, Uzbekistan).
- Fiscal deterioration and current deficits:
  - GCC region and Algeria: projected budget deficits of 13 percent of GDP this year, down from a surplus of 8½ percent of GDP in 2013.
  - CCA oil exporters: budget deficits of 5 percent of GDP this year, compared with a 3½ percent surplus in 2013.
- Adopted measures and composition:
  - Several countries have announced fiscal consolidation measures of about 4–6 percent of non-oil GDP or more.
  - Measures have typically focused on spending cuts—often public investment—while protecting public employment and wages.
  - Energy price reforms have been implemented in many GCC countries and Algeria; only the UAE, Oman, and recently Qatar have introduced energy price adjustment mechanisms tied to international benchmarks.
  - Non-oil revenue measures are limited so far; a GCC-wide value added tax (VAT) has been announced by policymakers as an intention.
- Medium-term trajectory and buffers:
  - Even after announced measures, fiscal deficits of GCC countries and Algeria are projected to average about 7 percent of GDP in 2021.
  - Cumulative deficits for GCC countries and Algeria are expected to reach almost $900 billion during 2016-21.
  - Gross government debt is projected to increase from 13 percent of GDP last year to about 45 percent of GDP in 2021 (group average), though debt ratios for some countries could exceed 100 percent of GDP by the end of the decade.
  - For the CCA oil exporters, cumulative deficits are much smaller: $32 billion during 2016-21; public debt could remain broadly unchanged at about 23 percent of GDP on aggregate assumptions.
  - According to Sovereign Wealth Fund Institute (SWFI) estimates, the GCC countries and Algeria have saved a combined $2.5 trillion in sovereign wealth funds and other savings vehicles.
- Magnitude of desirable fiscal consolidation (illustrative):
  - If policymakers decided to balance their books:
    - GCC countries and Algeria would face an adjustment of 10–15 percent of GDP.
    - CCA oil exporters would face an adjustment of about 5 percent of GDP.
  - Balancing budgets would, on average, require cutting today’s public expenditures by about one-third in the GCC countries and Algeria, and about one-quarter in the CCA oil exporters.
  - A $10 increase in the price of oil would reduce required fiscal adjustment by roughly 4 percent of GDP on average for the GCC countries and Algeria, and by 5 percentage points for the CCA countries in another illustrative metric.
- Illustrative revenue and spending options:
  - A broad-based 5 percent VAT would raise about 1½ percent of GDP in the GCC region.
  - Increasing public investment efficiency could save about 2 percent of GDP.

### Growth outlook, employment, and structural reform needs
- Real GDP growth forecasts:
  - GCC and Algeria: growth forecast to slow substantially in 2016; this year’s growth projected at 2.1 percent (well below the 2014 growth rate of 3.6 percent), with no recession projected.
  - CCA oil exporters: growth projected to hit a two-decade low this year at 1.1 percent, compared with 3.2 percent in 2015 and 5.4 percent in 2014; Azerbaijan’s GDP may contract by 3 percent this year; Kazakhstan forecast to narrowly avoid recession.
- Non-oil growth prospects (averages):
  - GCC region and Algeria: non-oil GDP growth expected to average 3½ percent during 2017–21, compared with 6½ percent during 2000–15.
  - CCA oil exporters: non-oil growth expected to average 2½ percent during 2017–21, compared with 8½ percent during 2000–15.
- Labor market implications:
  - United Nations estimates that 3.8 million people will enter the labor force in this region by 2021.
  - IMF estimates suggest unemployment could increase by 1.3 million people by 2021 in GCC and Algeria.
  - For all MENA oil exporters (including Iran, Iraq, Libya, and Yemen) unemployment could increase by 3 million, compared with the projected rise in the labor force by 10 million people.
- Structural reform priorities:
  - Improve business environment, reduce bureaucracy, enhance legal and regulatory frameworks.
  - Strengthen education and skills alignment with market needs.
  - Reduce public–private wage gaps and encourage nationals to seek private sector employment.
  - Foster financial development and inclusion, and privatize or restructure state-owned enterprises where feasible to improve productivity and raise temporary financing.

### Exchange rate regimes, external financing, and financial stability
- Exchange rate policy options:
  - Maintaining pegs can provide a nominal anchor, but requires large buffers and credible fiscal consolidation to remain sustainable under prolonged shocks.
  - Exchange rate depreciation can aid adjustment for more diversified economies but can raise inflation and financial stability risks, notably with high dollarization.
  - Countries introducing more exchange rate flexibility will need to modernize monetary policy frameworks and strengthen financial markets and communication.
- CCA and Algeria experience and risks:
  - Depreciation raised local-currency value of oil and other exports, providing short-term fiscal gains only if foreign-currency expenditures do not increase correspondingly.
  - Depreciation has heightened inflationary pressures, particularly in Azerbaijan and Kazakhstan, with inflation projected to reach double digits in 2016 in some cases.
  - Depreciations have stressed bank balance sheets through currency mismatches and increased dollarization in some CCA countries.
- Liquidity, borrowing costs, and deficit financing:
  - Government bond yields and CDS spreads have increased in several countries; interbank rates rose in the GCC following the U.S. Fed rate hike, with tighter domestic liquidity amplifying increases in some cases.
  - Budget deficits are being financed through a mix of asset drawdowns and debt issuance; governments withdrew deposits from local banking systems and sovereign wealth funds and, in some cases, borrowed from local banks.
  - If policymakers financed half of their deficits by issuing debt, total issuance would reach close to $100 billion given projected deficits (illustrative magnitude).
- Banking sector liquidity and credit:
  - Liquidity has tightened as government deposits were withdrawn and capital outflows occurred; credit growth has slowed sharply, especially in CCA countries.
  - Banks have tapped foreign funding: in GCC countries (excluding Saudi Arabia) and CCA oil exporters, increase in net foreign liabilities was about 5 percent of GDP last year; in Qatar, the increase was almost 10 percent of GDP.
  - Financial sector policy priorities include improving liquidity forecasting, ensuring effective liquidity-assistance frameworks, enforcing open-position limits, ensuring appropriate loan classification and provisioning, enhancing supervision, stress testing, insolvency and crisis management frameworks, and strengthening macroprudential frameworks.
- Nonperforming loans and corporate vulnerabilities:
  - NPLs may rise with slowing activity and depreciations, though NPL increases may manifest with lags.
  - Fiscal costs of contingent liabilities from the financial sector have historically been sizable in periods of stress.
  - Publicly traded corporate data show overall solid profitability entering the period of lower oil prices on average, but the bottom quartile of corporations had low profits relative to interest payments and face risks as economies slow.

### Policy trade-offs and recommendations
- Fiscal policy:
  - Implement sustained fiscal consolidation to preserve fiscal sustainability and support exchange rate pegs where applicable.
  - Sequence consolidation to protect essential spending (health, education) and vulnerable populations while targeting unproductive expenditures.
  - Broaden non-oil revenue bases (taxation, reduced exemptions, improved revenue administration) and continue energy price reforms with attention to budget transmission of gains.
  - Enhance medium-term fiscal frameworks, fiscal transparency, and inclusion of off-budget entities onto the budget.
- Monetary and exchange rate policy:
  - If maintaining pegs, ensure large financial buffers and credible fiscal adjustment; monitor forward markets and liquidity risks.
  - If increasing flexibility, modernize monetary policy frameworks, deepen FX and money markets, and strengthen central bank operations and communication.
- Financial sector policy:
  - Strengthen supervision, provisioning, capital buffers, and crisis management; enhance stress testing and macroprudential frameworks, particularly where dollarization is high.
  - Coordinate fiscal and monetary operations to avoid amplifying liquidity shocks.
- Structural reforms:
  - Deepen reforms to diversify economies, improve business climate, privatize or corporatize state-owned enterprises where appropriate, and foster private-sector-led job creation.
  - Improve education and skills, access to finance, and competition to raise non-oil growth and employment.
- IMF engagement:
  - The IMF can assist via advice, technical assistance and training, and—if needed—financial support.
  - Recent technical and analytical assistance examples include advice on medium-term fiscal frameworks, energy price reform, revenue administration, and financial sector and exchange rate policies.
  - The IMF is intensifying engagement through regional initiatives such as the GCC Meetings, Arab Forums, and CCA peer-to-peer events.

### Historical parallels: Box 1 — 1980s and 1990s experience
- Recent drop in oil prices parallels the 1986 decline and reflects a substantial—and potentially long-lived—shift in supply.
- 1980s outcomes:
  - Reserve drawdowns funded continued spending; Saudi Arabia issued domestic debt starting in 1988.
  - Most Gulf exporters reduced public investment while generally protecting social spending.
  - Real non-oil growth slowed from about 5 percent (first half of the 1980s) to zero (second half).
- 1990s lessons:
  - Institutional arrangements (SWFs, stabilization funds) can smooth fiscal volatility.
  - Financial hedging is technically feasible but politically sensitive.
  - Norway’s GPF cited as an example of accumulating buffers and managing volatility.

### Annex III — Financial sector policies implemented since June 2014
- Traditional measures:
  - Reducing reserve requirements (Azerbaijan).
  - Increasing loan to deposit ratio (Saudi Arabia).
  - Reducing the amount and frequency of T-bill auctions (Qatar).
  - Engaging in currency swaps (Kazakhstan).
  - Raising deposit insurance (Azerbaijan).
  - Algeria announced reactivation of refinancing facilities, but continued its liquidy absorption operations during 2014-15.
- Unconventional measures:
  - Placement of deposits at commercial banks by sovereign wealth funds (Azerbaijan).
  - Placement of deposits at commercial banks by pension funds (Kazakhstan).
  - Directed lending through commercial banks (Turkmenistan).
- Measures to maintain solvency:
  - Use of public funds for recapitalization (Algeria).
  - Consolidation of banks (Azerbaijan).
  - Purchase of NPLs; termination of licenses.
- Crisis-management and prudential responses:
  - Strengthening microprudential regulations; implementation of macroprudential measures.
  - Forbearance measures, including reducing capital requirements and allowing banks to operate below statutory capital requirements (Azerbaijan).
  - Restrictions on FX open position; provisioning on restructured loans.
- Supervisory and administrative actions:
  - Authorities requested local banks to stop selling option contracts on foreign exchange forwards.
  - Administrative controls on FX transactions.
- Macro policies affecting bank liquidity or asset quality:
  - Exchange rate policies: intervention to stem depreciation; devaluation and/or allowing depreciations; administrative controls on FX transactions.
  - Interest rate policy: increases in interest rates (in several GCC countries these policy changes followed an interest rate hike by the U.S. Federal Reserve); declines in interest rates; administrative controls on interest rates.
- Fiscal (deficit financing) options that affect banks:
  - Drawdown of SWF or other external assets.
  - External borrowing.
  - Domestic borrowing.
  - Drawdown of local bank deposits.
  - Arrears to domestic government suppliers.
- Country-specific notes:
  - Azerbaijan: reducing reserve requirements; raising deposit insurance; placement of sovereign wealth fund deposits at commercial banks; consolidation of banks; forbearance on capital; request to stop selling FX option contracts.
  - Algeria: reactivation of refinancing facilities; use of public funds for recapitalization; continued liquidity absorption operations during 2014-15.
  - Kazakhstan: engaging in currency swaps; placement of pension fund deposits at commercial banks.
  - Turkmenistan: directed lending through commercial banks.
  - Qatar: reducing the amount and frequency of T-bill auctions.
  - Saudi Arabia: increasing loan to deposit ratio.
  - GCC countries: several implemented interest rate increases following a U.S. Federal Reserve rate hike.

*Source: IMF Middle East and Central Asia Department executive summary (information as of April 2016).*

### EXECUTIVE SUMMARY_________________________________________________________________________7

### _mcd1603 - EXECUTIVE SUMMARY_________________________________________________________________________7

### Preface and Scope
- Prepared by the IMF’s Middle East and Central Asia Department under the general guidance of Masood Ahmed.
- Project directed by Aasim M. Husain; led by Martin Sommer. Contributors: Greg Auclair, Armand Fouejieu, Inutu Lukonga, Saad Quayyum, Amir Sadeghi, Gazi Shbaikat, Andrew Tiffin, Juan Trevino, and Bruno Versailles. Neil Hickey provided editorial support; Joe Procopio managed production. Hanan Altimimi Bane assisted with formatting and Esther George provided additional support.
- Report is generally based on information as of April 2016.
- Macroeconomic assumptions and oil prices are consistent with the April 2016 World Economic Outlook:
  - Average Brent oil price assumed at $36 a barrel in 2016.
  - Average Brent oil price assumed at $42 a barrel in 2017.
  - Brent oil price assumed to gradually increase to $51 a barrel in 2021.
- Geographic focus: Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates), Algeria, and oil exporters in the Caucasus and Central Asia (Azerbaijan, Kazakhstan, Turkmenistan, and Uzbekistan).
- Exclusions: MENA oil exporters primarily driven by conflicts (Iraq, Libya, and Yemen) or by the removal of sanctions (Iran) are not covered.
- Terminology: The word oil is used interchangeably for both crude oil and natural gas.

### Chapter 1 — Lower Oil Prices: A Challenging New Reality
- Central theme: Oil and natural gas are crucial commodities for the covered countries.
- Key dynamics:
  - Lower oil prices are compounded by other developments (see chapter listing of compounding factors).
  - Initial policy responses are documented and assessed.
  - Economic growth is slowing across the covered countries.

### Chapter 2 — Preserving Fiscal Sustainability
- Magnitude and nature of the fiscal challenge are assessed.
- Adopted adjustment measures are reported as significant.
- Despite measures, a challenging fiscal trajectory remains.
- Fiscal buffers vary considerably by country.
- The report quantifies the magnitude of desirable fiscal consolidation and presents illustrative options for fiscal consolidation.
- Growth impact of fiscal consolidation is analyzed.

### Chapter 3 — Maintaining External and Financial Stability
- Exchange rate policy options are evaluated.
- Experience of CCA countries and Algeria is described.
- The GCC exchange rate policy is analyzed separately.
- Lower oil prices have:
  - Pushed up borrowing costs and CDS spreads.
  - Reduced bank liquidity and dampened credit growth.
  - Created financial stability risks.
- Financial sector policy priorities are outlined.

### Chapter 4 — Generating Jobs and Growth
- Growth projections:
  - Growth will remain well below historical trends.
  - Low growth will push up unemployment.
- The chapter identifies key impediments to growth and job creation and prioritizes structural reform measures.

### Chapter 5 — Takeaways
- Synthesis of policy imperatives across fiscal, external, financial, and structural domains to address the shock from lower oil prices.

### Analytical and Empirical Content (selected)
- The report contains figures and boxes documenting:
  - GDP growth and oil dependence.
  - Oil prices and related budget revenue losses.
  - Foreign exchange reserves, public expenditures, exchange rate behavior, inflation, dollarization, and signs of pressures on exchange rate pegs for GCC, Algeria, and CCA oil exporters.
  - Borrowing costs, default risk, financing of fiscal deficits, commercial bank deposits, private sector credit, cross-border bank activities, nonperforming loans, contingent liabilities, corporate vulnerabilities, and long-term growth prospects.
  - Structural reform priorities and employment outlook for GCC and Algeria.
- Annexes include:
  - Annex I: Recently announced fiscal measures in MENA and CCA oil-exporting countries (as of March 2016).
  - Annex II: Policy trade-offs in devising budget deficit-financing strategies.
  - Annex III: Financial sector policies to address risks from lower oil prices.

### Implicit Policy Priorities Highlighted in the Report
- Preserve fiscal sustainability through calibrated consolidation while accounting for growth impacts.
- Maintain external and financial stability via appropriate exchange rate policy choices and financial sector measures to mitigate liquidity, credit, and solvency risks.
- Implement structural reforms to lift private-sector activity, generate jobs, and restore medium-term growth prospects.

*Source: IMF Middle East and Central Asia Department executive summary (information as of April 2016).*

### Executive Summary

### _mcd1603 - Executive Summary

### Major challenges and near-term outlook
- Lower oil prices have reduced growth, opened up large budget and trade deficits, and increased financial stability risks.
- The proliferation of conflicts in the MENA region continues to cause severe economic damage and significant spillovers.
- In the Caucasus and Central Asia (CCA), the adverse impact of lower oil prices has been compounded by slowdowns in Russia and China.
- Most MENA and CCA oil exporters have large financial buffers built up during the years of high oil prices that "can be drawn down in the coming years to smooth out—but not avoid—the adjustment to lower oil revenues."

### Oil dependence and price prospects
- Over the past 15 years, growth averaged:
  - almost 5 percent in the GCC region and Algeria,
  - more than 8 percent in CCA oil-exporting countries,
  - compared with 6 percent growth in all emerging markets and developing countries (EMDCs).
- Oil prices have plunged by some 60 percent since the middle of 2014.
- Hydrocarbon budget receipts are projected to have been reduced by more than 10 percent of GDP in all GCC countries, Algeria, and Azerbaijan over the past two years.
- Futures markets predict a modest recovery: from about $45 a barrel at present to about $50–$55 a barrel by the end of this decade, with unusually large uncertainty around that prediction.
- The value of oil and natural gas exports is projected to fall by almost $450 billion in the GCC countries and Algeria in 2016 compared with 2014; the corresponding estimate for the CCA oil exporters is $65 billion.
- The MENA and CCA oil importers are collectively projected to save only $20 billion on oil and gas imports this year compared with 2014.

### Fiscal challenges, policy responses, and required consolidation
- Initial responses:
  - GCC countries and Algeria have drawn down reserves and sovereign wealth fund assets to absorb the shock; most have started to rein in budget spending.
  - CCA countries used exchange rate depreciation to facilitate adjustment; some managed currencies tightly (Turkmenistan, Uzbekistan).
- Fiscal deterioration and current deficits:
  - GCC region and Algeria: projected budget deficits of 13 percent of GDP this year, down from a surplus of 8½ percent of GDP in 2013.
  - CCA oil exporters: budget deficits of 5 percent of GDP this year, compared with a 3½ percent surplus in 2013.
- Adopted measures and composition:
  - Several countries have announced fiscal consolidation measures of about 4–6 percent of non-oil GDP or more.
  - Measures have typically focused on spending cuts—often public investment—while protecting public employment and wages.
  - Energy price reforms have been implemented in many GCC countries and Algeria; only the UAE, Oman, and recently Qatar have introduced energy price adjustment mechanisms tied to international benchmarks.
  - Non-oil revenue measures are limited so far; a GCC-wide value added tax (VAT) has been announced by policymakers as an intention.
- Medium-term trajectory and buffers:
  - Even after announced measures, fiscal deficits of GCC countries and Algeria are projected to average about 7 percent of GDP in 2021.
  - Cumulative deficits for GCC countries and Algeria are expected to reach almost $900 billion during 2016-21.
  - Gross government debt is projected to increase from 13 percent of GDP last year to about 45 percent of GDP in 2021 (group average), though debt ratios for some countries could exceed 100 percent of GDP by the end of the decade.
  - For the CCA oil exporters, cumulative deficits are much smaller: $32 billion during 2016-21; public debt could remain broadly unchanged at about 23 percent of GDP on aggregate assumptions.
  - According to Sovereign Wealth Fund Institute (SWFI) estimates, the GCC countries and Algeria have saved a combined $2.5 trillion in sovereign wealth funds and other savings vehicles.
- Magnitude of desirable fiscal consolidation (illustrative):
  - If policymakers decided to balance their books:
    - GCC countries and Algeria would face an adjustment of 10–15 percent of GDP.
    - CCA oil exporters would face an adjustment of about 5 percent of GDP.
  - Balancing budgets would, on average, require cutting today’s public expenditures by about one-third in the GCC countries and Algeria, and about one-quarter in the CCA oil exporters.
  - A $10 increase in the price of oil would reduce required fiscal adjustment by roughly 4 percent of GDP on average for the GCC countries and Algeria, and by 5 percentage points for the CCA countries in another illustrative metric.
- Illustrative revenue and spending options:
  - A broad-based 5 percent VAT would raise about 1½ percent of GDP in the GCC region.
  - Increasing public investment efficiency could save about 2 percent of GDP.

### Growth outlook, employment, and structural reform needs
- Real GDP growth:
  - GCC and Algeria: growth forecast to slow substantially in 2016; this year’s growth projected at 2.1 percent (well below the 2014 growth rate of 3.6 percent), with no recession projected.
  - CCA oil exporters: growth projected to hit a two-decade low this year at 1.1 percent, compared with 3.2 percent in 2015 and 5.4 percent in 2014; Azerbaijan’s GDP may contract by 3 percent this year; Kazakhstan forecast to narrowly avoid recession.
- Non-oil growth prospects (averages):
  - GCC region and Algeria: non-oil GDP growth expected to average 3½ percent during 2017–21, compared with 6½ percent during 2000–15.
  - CCA oil exporters: non-oil growth expected to average 2½ percent during 2017–21, compared with 8½ percent during 2000–15.
- Labor market implications:
  - United Nations estimates that 3.8 million people will enter the labor force in this region by 2021.
  - IMF estimates suggest unemployment could increase by 1.3 million people by 2021 in GCC and Algeria.
  - For all MENA oil exporters (including Iran, Iraq, Libya, and Yemen) unemployment could increase by 3 million, compared with the projected rise in the labor force by 10 million people.
- Structural reform priorities to foster diversification and job creation:
  - Improve business environment, reduce bureaucracy, enhance legal and regulatory frameworks.
  - Strengthen education and skills alignment with market needs.
  - Reduce public–private wage gaps and encourage nationals to seek private sector employment.
  - Foster financial development and inclusion, and privatize or restructure state-owned enterprises where feasible to improve productivity and raise temporary financing.

### Exchange rate regimes, external financing, and financial stability
- Exchange rate policy options:
  - Maintaining pegs can provide a nominal anchor, but requires large buffers and credible fiscal consolidation to remain sustainable under prolonged shocks.
  - Exchange rate depreciation can aid adjustment for more diversified economies but can raise inflation and financial stability risks, notably with high dollarization.
  - Countries introducing more exchange rate flexibility will need to modernize monetary policy frameworks and strengthen financial markets and communication.
- Experience and risks in CCA and Algeria:
  - Depreciation raised local-currency value of oil and other exports, providing short-term fiscal gains only if foreign-currency expenditures do not increase correspondingly.
  - Depreciation has heightened inflationary pressures, particularly in Azerbaijan and Kazakhstan, with inflation projected to reach double digits in 2016 in some cases.
  - Depreciations have stressed bank balance sheets through currency mismatches and increased dollarization in some CCA countries.
- Liquidity, borrowing costs, and financing of deficits:
  - Government bond yields and CDS spreads have increased in several countries; interbank rates rose in the GCC following the U.S. Fed rate hike, with tighter domestic liquidity amplifying increases in some cases.
  - Budget deficits are being financed through a mix of asset drawdowns and debt issuance; governments withdrew deposits from local banking systems and sovereign wealth funds and, in some cases, borrowed from local banks.
  - If policymakers financed half of their deficits by issuing debt, total issuance would reach close to $100 billion given projected deficits (illustrative magnitude).
- Banking sector liquidity and credit:
  - Liquidity has tightened as government deposits were withdrawn and capital outflows occurred; credit growth has slowed sharply, especially in CCA countries.
  - Banks have tapped foreign funding: in GCC countries (excluding Saudi Arabia) and CCA oil exporters, increase in net foreign liabilities was about 5 percent of GDP last year; in Qatar, the increase was almost 10 percent of GDP.
  - Financial sector policy priorities include improving liquidity forecasting, ensuring effective liquidity-assistance frameworks, enforcing open-position limits, ensuring appropriate loan classification and provisioning, enhancing supervision, stress testing, insolvency and crisis management frameworks, and strengthening macroprudential frameworks.
- Nonperforming loans (NPLs), contingent liabilities, and corporate sector vulnerabilities:
  - NPLs may rise with slowing activity and depreciations, though NPL increases may manifest with lags.
  - Fiscal costs of contingent liabilities from the financial sector have historically been sizable in periods of stress.
  - Publicly traded corporate data show overall solid profitability entering the period of lower oil prices on average, but the bottom quartile of corporations had low profits relative to interest payments and face risks as economies slow.

### Policy trade-offs and recommendations
- Fiscal:
  - Implement sustained fiscal consolidation to preserve fiscal sustainability and support exchange rate pegs where applicable.
  - Sequence consolidation to protect essential spending (health, education) and vulnerable populations while targeting unproductive expenditures.
  - Broaden non-oil revenue bases (taxation, reduced exemptions, improved revenue administration) and continue energy price reforms with attention to budget transmission of gains.
  - Enhance medium-term fiscal frameworks, fiscal transparency, and inclusion of off-budget entities onto the budget.
- Monetary and exchange rate:
  - If maintaining pegs, ensure large financial buffers and credible fiscal adjustment; monitor forward markets and liquidity risks.
  - If increasing flexibility, modernize monetary policy frameworks, deepen FX and money markets, and strengthen central bank operations and communication.
- Financial sector:
  - Strengthen supervision, provisioning, capital buffers, and crisis management; enhance stress testing and macroprudential frameworks, particularly where dollarization is high.
  - Coordinate fiscal and monetary operations to avoid amplifying liquidity shocks.
- Structural reforms:
  - Deepen reforms to diversify economies, improve business climate, privatize or corporatize state-owned enterprises where appropriate, and foster private-sector-led job creation.
  - Improve education and skills, access to finance, and competition to raise non-oil growth and employment.
- IMF engagement:
  - The IMF can assist via advice, technical assistance and training, and—if needed—financial support.
  - Recent technical and analytical assistance examples include advice on medium-term fiscal frameworks, energy price reform, revenue administration, and financial sector and exchange rate policies.
  - The IMF is intensifying engagement through regional initiatives such as the GCC Meetings, Arab Forums, and CCA peer-to-peer events.

*Source: _mcd1603 - Executive Summary*

### Box 1. Experience of MENA Oil Exporters during the 1980s and 1990s

### Box 1. Experience of MENA Oil Exporters during the 1980s and 1990s

### Overview
- The recent drop in oil prices has strong parallels with the price decline in 1986 and, unlike many past price falls linked to weakening global demand (following U.S. recessions in 1990–91 and 2001; the Asian crisis in 1997–98; and the global financial crisis in 2008–09), the most recent decline also reflects a substantial—and potentially long-lived—shift in supply (Husain and others 2015).
- Like the 1986 episode, the recent drop followed a period of rapid growth in supply sources and a shift in policy by key producers, especially those from OPEC; consequently, the drop in global oil prices is expected to be protracted.
- The average oil price metric referenced is an average of Brent, WTI, and Dubai oil prices (2010 U.S. dollars).

### The 1980s: A Cautionary Tale
- Pre-1986 context:
  - Two positive oil price shocks in the 1970s led most oil exporters to deliberately increase spending, notably on infrastructure and social spending.
  - Many exporters outside the region (Mexico, Venezuela, Norway) followed similar spending patterns.
- Early 1980s pressures:
  - As oil prices started to decline in the early 1980s, public finances came under strain partly due to growing expenditures and, for key OPEC exporters, falling export volumes driven by efforts to maintain prices in the face of growing non-OPEC supply.
- Trigger for the 1986 crash:
  - A policy shift by OPEC producers who expanded production to arrest declining market share led to the abrupt price fall in 1986.
- Gulf states’ position and response:
  - Some exporters (especially in the GCC) entered the mid-1980s with fiscal buffers from large windfalls and increased official reserves.
  - Reserve accumulation eased with declining (OPEC) output volumes; Saudi Arabia bore the largest portion of output reductions and financed continued spending by drawing down reserves.
  - Funding response: drawdown of reserves; in Saudi Arabia, issuance of domestic debt starting in 1988 and continuing until the late 1990s.
  - Adjustment response: most Gulf exporters reduced public investment significantly while generally leaving social spending untouched.
  - Growth impact: real non-oil growth slowed from an average of about 5 percent in the first half of the 1980s to zero in the second half.
  - Fiscal buffers and accumulated surpluses allowed Gulf countries to run persistent fiscal deficits into the late 1980s, avoiding potentially disruptive exchange rate moves.

### The 1990s: Increased Prudence and Buildup of Buffers
- Institutional reforms:
  - The 1990s saw increased use of institutional arrangements to shield fiscal policy from oil price volatility, notably oil stabilization funds and sovereign wealth funds (SWFs).
  - Kuwait Investment Authority established in 1953; Abu Dhabi in the 1970s; Oman in the 1980s; Norway’s Government Petroleum Fund (GPF) established in 1990 and started accumulating resources in 1996, helping cope with the 1998 price decline after the Asian crisis.
- Hedging and risk management:
  - Some governments began hedging oil price risks in financial markets, but overall interest remained modest due to political costs of foregone gains during price upturns.
  - Mexico began using financial risk-management tools in 1990 to secure a price for budget planning.
  - Ecuador bought put options in 1993 and used a swap arrangement to secure a floor price; when prices rose, the hedging was criticized as generating “losses.”
- Key lessons:
  - Institutional arrangements (SWFs, stabilization funds) can smooth fiscal volatility.
  - Financial hedging is technically feasible but politically sensitive when prices rise.
  - Norway’s GPF is cited as a key example of good practice in accumulating buffers and managing volatility.

*International Monetary Fund*

### Annex III. Financial Sector Policies to Address Risks from

### Annex III. Financial Sector Policies to Address Risks from Lower Oil Prices

### Selected Policies Implemented since June 2014
- Traditional measures included:
  - Reducing reserve requirements (Azerbaijan)
  - Increasing loan to deposit ratio (Saudi Arabia)
  - Reducing the amount and frequency of T-bill auctions (Qatar)
  - Engaging in currency swaps (Kazakhstan)
  - Raising deposit insurance (Azerbaijan)
  - Algeria announced reactivation of refinancing facilities, but continued its liquidy absorption operations during 2014-15.
- Unconventional measures included:
  - Placement of deposits at commercial banks by sovereign wealth funds (Azerbaijan)
  - Placement of deposits at commercial banks by pension funds (Kazakhstan)
  - Directed lending through commercial banks (Turkmenistan)
- Measures to maintain solvency of the banking system:
  - Use of public funds for recapitalization (Algeria)
  - Consolidation of banks (Azerbaijan)
  - Purchase of NPLs
  - Termination of licenses
- Crisis-management and prudential responses:
  - Strengthening microprudential regulations
  - Implementation of macroprudential measures
  - Forbearance measures, including reducing capital requirements and allowing banks to operate below statutory capital requirements (Azerbaijan)
  - Restrictions on FX open position
  - Provisioning on restructured loans
- Other supervisory and administrative actions:
  - Authorities requested local banks to stop selling option contracts on foreign exchange forwards
  - Administrative controls on FX transactions

### Macro policies with direct impact on banking system liquidity or asset quality
- Exchange rate policies:
  - Intervention to stem depreciation
  - Devaluation and/or allowing depreciations
  - Administrative controls on FX transactions
- Interest rate policy:
  - Increases in interest rates (in several GCC countries these policy changes followed an interest rate hike by the U.S. Federal Reserve)
  - Declines in interest rates
  - Administrative controls on interest rates

### Fiscal (Deficit Financing) Options that affect banks
- Drawdown of SWF or other external assets
- External borrowing
- Domestic borrowing
- Drawdown of local bank deposits
- Arrears to domestic government suppliers

### Key implementation notes and country references (as described)
- Azerbaijan: reducing reserve requirements; raising deposit insurance; placement of sovereign wealth fund deposits at commercial banks; consolidation of banks; forbearance on capital; request to stop selling FX option contracts.
- Algeria: reactivation of refinancing facilities; use of public funds for recapitalization; continued liquidity absorption operations during 2014-15.
- Kazakhstan: engaging in currency swaps; placement of pension fund deposits at commercial banks.
- Turkmenistan: directed lending through commercial banks.
- Qatar: reducing the amount and frequency of T-bill auctions.
- Saudi Arabia: increasing loan to deposit ratio.
- GCC countries: several implemented interest rate increases following a U.S. Federal Reserve rate hike.

*Source: Annex III. Financial Sector Policies to Address Risks from Lower Oil Prices, _mcd1603 - Annex III. Financial Sector Policies to Address Risks from*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/dp/2016/_mcd1603.pdf_