October 2016
Deepening conflicts, low oil prices, and spillovers from the slowdowns in Russia and China continue to weigh on economic growth in the Middle East, North Africa, Afghanistan, and Pakistan (MENAP) and the Caucasus and Central Asia (CCA) regions.
Middle East, North Africa, Afghanistan, and Pakistan (MENAP) oil exporters continue to face an exceptionally challenging environment as low oil prices and conflicts continue to weigh on economic activity, fiscal and external balances, and the financial sector. Many have made progress in fiscal consolidation, yet sustained efforts will be required over the medium term to place public finances on a sound footing. Plans to diversify economies away from oil and create jobs for the rapidly-growing populations have also been announced. Such economic transformation will take time. Careful and steady implementation of the diversification plans will be key to their success. In addition, policymakers need to remain vigilant about the financial stability risks, especially tightening liquidity and the risk of deteriorating asset quality.
Macroeconomic stabilization is advancing on the heels of recent energy subsidy reforms and low oil prices. Yet growth remains weak and fragile amid ongoing regional conflicts, lingering structural impediments, and subdued external demand. Over the medium term, growth is set to remain too low to address persistently high unemployment and low economic inclusiveness. Fiscal space is limited by high debt service costs and large wage bills and, in some cases, external vulnerabilities are still high. To boost private sector growth and employment, deeper structural reforms are needed to lower business costs, improve access to finance and export markets, and enhance worker talent. Greater exchange rate flexibility would also help improve competitiveness in some cases.
Fiscal accommodation and exchange rate adjustment have helped the Caucasus and Central Asia (CCA) mitigate the immediate impact from large and persistent external shocks, particularly the slump in commodity prices and weaker growth in key trading partners. Growth is starting to recover, but these shocks have left the region with increased fiscal, external, and financial sector vulnerabilities, along with less policy space and weaker medium-term prospects. Policies should continue to support growth in the near term where policy space is available, while aiming to reduce vulnerabilities over time, including through the formulation of credible multiyear fiscal plans, modernization of monetary policy frameworks, and strengthening of financial supervision. Structural transformation to diversify away from commodities and reduce reliance on remittances is needed to improve medium-term growth prospects, boost job creation, and avoid a deterioration in living standards.
Weaker commodity prices, slower global growth, and higher global risk aversion are the channels through which the Middle East, North Africa, Afghanistan, and Pakistan (MENAP) and the Caucasus and Central Asia (CCA) economies could be most affected by China’s rebalancing, especially if the rebalancing leads to a hard landing. Overall, the impact on the MENAP and CCA regions is likely to be small—between 0.01 percent and 0.1 percent for each 1 percentage point slowdown in China’s growth—given the limited bilateral trade and financial linkages with China. Within the regions, commodity exporters would be impacted the most. On the positive side, China’s One Belt One Road (OBOR) investments, mainly in infrastructure, could help increase growth in the CCA and Pakistan—even if this investment is less than originally planned. China’s rebalancing also presents an opportunity for the region to increase consumption-oriented exports, for example, tourism, agricultural products, and clothing, while creating jobs. To reap these benefits, however, countries need to step up structural reforms to improve their business environment and boost productivity and competitiveness.
Despite efforts to consolidate, fiscal deficits will remain large in the Gulf Cooperation Council (GCC), the Caucasus and Central Asia (CCA) oil exporters, and Algeria over the medium term. Countries will need robust strategies to finance these deficits, striking a balance between drawing down assets and issuing debt. These financing choices should be underpinned by strong institutional arrangements and clear medium-term fiscal frameworks. In the short term, constraints on domestic financing sources will lead countries to rely heavily on external financing. But the scale of ongoing financing needs provides opportunities and incentives to develop domestic debt markets, which could generate broader economic benefits.
