How the Middle East and Central Asian Countries Can Reduce Debt and Preserve Growth

IMF News, November 13, 2018

Source details

Canonical URL: How the Middle East and Central Asian Countries Can Reduce Debt and Preserve Growth

Other formats

Bibliographic details

Authors: Anastasia Guscina, Boaz Nandwa Middle East, Central Asia Department November
Published: November 13, 2018

Overview

“Well-designed public finance reforms can help policymakers reduce debt while preserving growth and protecting the most vulnerable,” said Jihad Azour, Director of the Middle East and Central Asia Department.
Tightening global financial conditions have increased the urgency of reducing budget deficits and debt in countries of the Middle East and Central Asia.
The buildup of debt in recent years—which now exceeds 50 percent of GDP in almost half of the countries in the region—requires urgent action.

Regional challenges and macroeconomic context

Rapidly expanding labor force and high unemployment, especially among youth and women:
- The prospect of absorbing 5 million workers each year for the Middle East, North Africa, Afghanistan, and Pakistan (MENAP) region.
- One in five young people are already unemployed.
If governments do not act, increasing portions of budgets will be spent on interest payments and paying down debt rather than on investments in physical and human capital that promote growth.

Lessons from country experiences in reducing deficits

The composition of fiscal consolidation matters for growth and equity; how expenditures are cut or revenues increased determines outcomes.
Countries that reduced deficits while preserving public investment experienced:
- Higher growth.
- A more equal distribution of income.
Specific reform successes:
- Subsidy and public wage reforms combined with prioritizing social spending (education, health care, safety nets) were associated with higher long-term growth and greater income equality.
- Studies of the MENAP region have shown that each dollar of government resources diverted from energy subsidies toward productive investment translated into two dollars of additional growth over the long term.
Combinations of expenditure cuts and broader fiscal reforms to increase tax collection produced longer-lasting benefits than one-sided measures.

Recent reforms and their outcomes in MENAP and CCA

Over the past three years, most countries in MENAP and the Caucasus and Central Asia (CCA) adopted mixes of spending cuts and revenue-boosting measures that reduced deficits—but these reforms were not always growth friendly.
MENAP oil exporters (examples given: Bahrain and Iran):
- Mostly managed to protect capital spending and reform subsidies.
- Were not able to sufficiently increase tax collection, threatening the durability of gains.
MENAP oil importers (example given: Tunisia):
- Managed to mobilize tax revenues, but gains were partly offset by higher subsidies due to rising oil prices as subsidy reforms were not completed.
- Spending on infrastructure took a big hit in MENAP oil importers like Djibouti and Mauritania despite major gaps.
CCA-specific issues:
- Scope to improve public procurement processes and oversight of state-owned enterprises to preserve budget resources and minimize fiscal risk.
- Scope to raise the contribution of corporate taxes to revenues to be more in line with those raised from personal income taxes.

Policy directions and recommendations

Revenue-side measures (MENAP focus, especially oil exporters):
- Increase tax revenues where the region lags emerging market peers.
- MENAP oil exporters collect less than 10 percent of GDP in non-oil tax revenues, less than half the emerging market average of close to 20 percent of GDP.
- Reduce generous corporate tax exemptions that favor large businesses over small and medium enterprises (example: Jordan).
- Make tax systems more progressive (examples: Jordan and Iran).
- Broaden the tax base (examples: Bahrain and Egypt).
- Achieve a more equitable allocation of the tax burden by increasing taxes on wealth—such as property, inheritance, capital gains, dividends, and interest—and gradually replacing more regressive and costly stamp duties and fees with a personal income tax.
Spending-side measures:
- Budget for the likely increase in debt servicing costs and improve the quality of spending.
- Increase, or at the very least preserve, investments in physical and human capital.
- Reduce the public wage bill in countries such as Algeria, Kuwait, and Tunisia.
- Complete reform of wasteful subsidies and transfers that disproportionately benefit the rich to allow governments to boost social spending.
- Social spending in the MENAP region is only a third of the emerging market average.
Public investment management and governance:
- Ensure infrastructure spending translates into inclusive growth by improving public investment management frameworks, including project appraisal, selection, and evaluation.
- Increase government transparency and accountability to reduce corruption and misappropriation of public resources and to help increase tax revenues.
- Better perceptions of government accountability would lower the cost of borrowing for both the sovereign and the private sector, further boosting investment and growth.

Key statistics and exact figures from the report

Debt now exceeds 50 percent of GDP in almost half of the countries in the region.
MENAP labor absorption challenge: 5 million workers each year.
Youth unemployment: one in five young people are already unemployed.
Long-term growth impact: each dollar diverted from energy subsidies toward productive investment translated into two dollars of additional growth.
MENAP oil exporters collect less than 10 percent of GDP in non-oil tax revenues.
Emerging market average for non-oil tax revenues: close to 20 percent of GDP.
MENAP social spending is only a third of the emerging market average.

Content based on “How the Middle East and Central Asian Countries Can Reduce Debt and Preserve Growth,” by Anastasia Guscina and Boaz Nandwa, Middle East and Central Asia Department, November 13, 2018.