Debt Clouds over the Middle East

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Debt Clouds over the Middle East

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Bibliographic details

• Authors: ADNAN MAZAREI
• Published: September 1, 2023

Overview and stakes

• Parts of the Middle East and North Africa (MENA) are "at the brink of a debt crisis."
• Rising public debt and tighter global financing conditions threaten economic growth and sociopolitical stability.
• The crisis is driven by scarcer low-interest financing, reduced unconditional financial support from affluent MENA oil producers, and difficult domestic social conditions that limit room for fiscal consolidation.
• A narrow escape route exists but requires bold, proactive measures; otherwise debt restructuring may become unavoidable.

Crisis origins

• Root causes combine misfortune and policy failures across countries:
  • Persistent structural issues: weak governance and regulatory frameworks; state-controlled economies; bloated public sectors that stifle private sector growth; low domestic revenue mobilization; poorly targeted subsidies.
  • Reliance on fixed exchange rates and debt financing.
  • External shocks: the pandemic; spillovers from Russia’s invasion of Ukraine; higher food prices.
  • Societal challenges and distrust in government that impede equitable distribution of adjustment burdens.
• Public debt has often been used as a temporary stop-gap without durable solutions.

Country-specific conditions

• Egypt:
  • Years of economic stagnation linked in part to the military’s pervasive control over the economy.
  • Pandemic impact on tourism and surging food import costs after Russia’s war in Ukraine.
  • Persistent budget deficits and maintaining a fixed exchange rate led to substantial financing needs met partly by short-term capital inflows.
  • As noted in the IMF’s April 2023 Fiscal Monitor, Egypt’s gross financing needs in 2023 amount to 35 percent of its GDP, leaving it highly susceptible to interest rate hikes and rollover risks.
• Jordan:
  • Low growth partly due to an overvalued fixed exchange rate, geopolitical and economic disruptions.
  • Large influx of Syrian refugees and trade disruptions following the Syrian civil war.
  • Fiscal pressure from hefty subsidies, public enterprise transfers, and security expenditures; heavy dependence on official aid.
  • Stronger policymaking framework and performing well under current IMF program, but high debt makes it very vulnerable.
• Lebanon:
  • Crisis driven by an unsustainable system of fixed exchange rates and weak public finances requiring high interest rates to attract foreign inflows—described as a "classic Ponzi scheme."
  • Political deadlock and banking sector influence precipitated a multifaceted economic and social crisis and default on domestic and external sovereign debt.
• Tunisia:
  • Initially showed democratic and governance improvements post–Arab Spring but government’s growing role as employer and subsidy provider created vulnerabilities.
  • COVID-19 shock weakened the economy and budget (Mazarei and Loungani 2023).
  • Authorities maintained exchange rate stability when unaffordable, relying on external official inflows during democratic transition.
  • Recent political upheavals, erosion of democratic progress, and refusal to implement necessary reforms have eroded debt repayment capacity, pushing Tunisia toward debt distress.

Historical context: previous debt crises

• MENA experienced debt distress episodes in the 1980s and 1990s due to internal and international conflicts and adverse global conditions, including commodity price shifts.
• Past responses included restructuring primarily public and publicly guaranteed debt via Paris Club agreements, "Brady deals" with private banks, and structural adjustment programs.
• Debt rescheduling occurred again in the 1990s and early 2000s—especially for Egypt, Iraq, and Jordan—with substantial international support.
• Today, the road to restructuring is more complex and challenging than in earlier episodes.

The new debt reality and restructuring challenges

• Advances: introduction of collective action clauses in sovereign bond contracts has hastened restructuring of sovereign Eurobonds.
• New complexities and flaws in global financial architecture make restructuring more difficult:
  • Rise of China and other non–Paris Club creditors fragments the official creditor base and makes restructuring more political, slower, and more challenging.
  • Private creditors have been reluctant and tardy in providing debt relief.
  • Significant domestic debt (e.g., Egypt) complicates restructuring because domestic debt is often held by local banks and pensions.
  • The Group of Twenty Common Framework applies only to low-income countries and is not applicable to most MENA middle-income countries; exceptions noted are Sudan and Yemen but both face conflict-related constraints.
• The restructuring ordeal in Sri Lanka is cited as evidence of potential lengthy delays and trauma in modern restructurings.

Near-term outlook and constraints ("What next?")

• Risks could be mitigated by a combination of growth-boosting policies, new financing, and fiscal consolidation—but prospects appear grim due to:
  • Weak global growth forecasts and persistently high inflation.
  • Difficulty securing external financing; if obtained, financing will carry high interest rates.
  • Gulf Cooperation Council oil-rich nations now require borrowers’ concrete, credible commitment to structural reforms as a condition for aid, including reforms to attract foreign direct investment.
  • Fiscal consolidation may not reduce debt (as noted in the IMF’s April 2023 World Economic Outlook) and will be politically and socially difficult, especially cuts to subsidies.
• Some countries might delay adjustment hoping for donor or multilateral rescue or resort to "inflation surprises" to ease domestic debt burdens (as predicted in the IMF’s May 2023 Regional Economic Outlook for the Middle East and Central Asia).
• A preferable approach, if restructuring is unavoidable, is preemptive restructuring as part of broader corrective actions to limit economic disruptions.

Policy recommendations and priority actions

• All high-debt MENA countries must address governance issues and credibly commit to reforms (ERF-FDL 2022).
• Country-specific recommendations:
  • Egypt: dismantle overbearing regulatory systems; reduce the army’s role in the economy; pursue solid privatization to attract foreign investment.
  • Jordan: implement deeper structural reforms to avert crisis.
  • Tunisia: reverse erosion of democracy and undertake crucial reforms promptly.
  • Lebanon: urgently form a government that transcends confessional divisions and steer the country toward reform.
• General guidance:
  • Combine growth-oriented policies, new financing, and fiscal consolidation where feasible.
  • Consider preemptive debt restructuring if necessary, as part of a comprehensive reform package.
  • Time is of the essence; swift, targeted interventions and readiness to face restructuring are essential.

Source: Debt Clouds over the Middle East by Adnan Mazarei (F&D Magazine, September 2023).

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