Growth and Stability in the Middle East and North Africa

Economic Performance

This section discusses the region's recent performance in sustaining economic growth in a context of domestic and external financial stability. Following a look at developments in the main macroeconomic aggregates, it analyzes structural aspects, recent policy actions, and terms of trade.

Macroeconomic Aggregates

Although MENA countries suffered the consequences of weak economic activity in industrial countries in the early 1990s, the crisis triggered by Iraq's invasion of Kuwait, and unsatisfactory oil-market conditions, the region achieved positive rates of real economic growth throughout 1989-94 with GDP expanding at an annual average rate of 3.2 percent. This growth exceeded that of Africa (1.6 percent) and Latin America (2.9 percent); only Asian countries recorded higher GDP growth (7.5 percent). Nevertheless, burgeoning population has caused annual average per capita real GDP growth to stagnate. In contrast, developing countries as a whole were able to increase their real per capita GDP by 3 percent and industrial countries by 1.3 percent during this period.

Growth performance varied among various country groups and countries in the region.

Inflation in MENA countries has been fairly restrained. In 1989-94, the weighted average consumer price index of the region increased annually by about 16 percent, compared with 47 percent for developing countries as a group. Within the MENA region, inflation in oil-exporting countries was on average lower than in non-oil exporters, reflecting tighter monetary policies, the nominal anchor provided by pegging most of these countries' currencies to the U.S. dollar, and the "safety valve" operating through the balance of payments to reduce excessive demand, although at the cost of erosion in international reserves and related investment income. Nevertheless, since the beginning of the 1990s the inflation rate in oil-exporting countries as a group has been increasing, while that in non-oil exporting countries has been declining, culminating in a relatively better inflation performance in the latter group in 1994.

At the individual country level, 12 MENA countries achieved single-digit inflation during 1989-94, and five countries (Bahrain, Kuwait, Oman, Qatar, and Saudi Arabia) had better inflation performance than that of the average for industrial countries. Egypt significantly reduced inflation during this period by strengthening fiscal and monetary policies. By contrast, Sudan recorded annual inflation rates of over 100 percent throughout the period. Lebanon, Somalia, the Republic of Yemen, and, to a lesser extent, Algeria and the Islamic Republic of Iran also suffered high inflation.

The external position of the MENA region deteriorated sharply in early 1991, but then improved steadily (Chart 3). As a ratio to GDP, the current account deficit (including official transfers) averaged 5 percent during 1989-94, compared with 1.3 percent in developing countries as a group. Among developing countries, sub-Saharan Africa was the only region to register larger current account imbalances.

The volume of exports of the MENA region increased at an annual average rate of 5.6 percent during 1989-94, compared with 8.4 percent for developing countries as a whole. On average, export growth in oil exporters was better than in non-oil exporters, which nevertheless experienced increased export volume growth during 1991-94. The growth in import volumes in the MENA region was lower than the growth in export volumes during 1989-94--amounting to an annual average of 2.8 percent. Within the region, the annual average growth in imports of oil exporters was slower than that of the remaining countries, reflecting the sharp decline in imports by the oil exporters during 1993-94, but also the increased access to financing by some non-oil countries associated with their adjustment process.

MENA countries adopted various approaches to financing external current account deficits. The GCC countries relied heavily on using their gross foreign assets, but also resorted to some external borrowing. Non-GCC countries mainly relied on medium- and long-term loans from official sources. Inflows from private sources were important for only a few countries (Egypt, Israel, and Lebanon), while most foreign direct investment in the region was accounted for by flows to Egypt, Israel, Morocco, and Tunisia.

During 1989-94 several countries resorted to exceptional financing in the form of rescheduling and accumulating arrears on debt service. Paris Club reschedulings were concluded for Algeria (1994 and 1995), Egypt (1991), Jordan (1989, 1992, and 1994), Mauritania (1989 and 1993), and Morocco (1990 and 1992). Rescheduling of commercial bank debt took place for Algeria (1992), Jordan (1993), and Morocco (1990). Foreign exchange reserves of oil countries declined, while those of other countries as a group increased more or less steadily during this period both in absolute terms and as a ratio to their imports of goods and services.

The total external public and publicly guaranteed debt of MENA countries increased by $44 billion during 1989-94, of which one third was accounted for by oil-exporting countries. This was a historical aberration reflecting the aftermath of the 1990-91 regional conflict. Saudi Arabia has repaid the bank loan syndication contracted after the conflict and Kuwait is in the process of doing so. As a percentage of GDP, the external debt of the region remained more or less stable. The debt-to-GDP ratio of oil-exporting countries, although relatively small, increased gradually, while that of non-oil exporting countries declined from 100 percent in 1989 to 69 percent in 1994. Developments in Egypt, Jordan, and Morocco mainly accounted for this decline. In Egypt, the decline in the early 1990s was largely due to reductions in the stock of debt granted by official bilateral creditors. Jordan undertook debt-reduction operations with commercial banks and also implemented reschedulings with, and was granted debt forgiveness by, some bilateral official creditors. Morocco benefited from the cancellation of the entire stock of debt it owed to Saudi Arabia.

The debt-service burden of the region remained at comfortable levels during this period. Oil-exporting countries' debt service, as a percentage of exports of goods and services, picked up, with amortization payments coming due at the same time as export earnings fell. Debt servicing of the non-oil exporting countries declined because of lower stocks of outstanding debt and the impact of debt rescheduling. Declines in the debt-service ratio were substantial in Algeria, Egypt, Israel, and Jordan. During 1989-94, the largest increase in debt and debt-service ratios, albeit from very low levels, was observed in Lebanon and was associated with the financing of the reconstruction program.

Accounting for Macroeconomic Performance

Interaction among the underlying structural elements of the MENA economies, the stance of macroeconomic and structural reform policies, and developments in the countries' terms of trade have determined the region's economic performance.

Underlying Structure

Even though there is considerable economic and financial diversity among MENA countries, several share similar structural economic characteristics that have influenced their recent economic performance. Four structural aspects stand out in particular:

While the economy of the region as a whole is relatively diversified, most countries have a narrow economic base. In many countries, a single sector--indeed a single product--constitutes most domestic output. The most vivid example is oil, which accounts for over 50 percent of GDP in almost all oil-exporting countries. Agriculture accounts for a similar proportion of GDP in Somalia and Sudan, and around a quarter of GDP in the Islamic Republic of Iran, Mauritania, and the Republic of Yemen. Manufacturing is significant and well diversified only in Israel, Morocco, and Tunisia. Despite disruptions caused by the 1990-91 regional crisis and civil unrest, tourism remains an important component of output in a number of MENA countries (Egypt, Israel, Morocco, and Tunisia) and has enjoyed a higher growth rate than agriculture or manufacturing in these countries since 1989.

The narrow productive and export bases make several MENA economies vulnerable to exogenous shocks. In oil-exporting countries, fluctuations in the international price of oil have a direct impact on export receipts and government revenues (in GCC economies, the share of oil revenues in total revenues ranges from about 60 percent in Bahrain to about 80 percent in the United Arab Emirates), as well as an indirect impact through the role of government expenditure in determining overall economic activity and employment (Chart 4). Furthermore, economic developments in oil-exporting countries have important consequences for other countries in the region, which are dependent on transfers from workers in oil-producing countries.

At the same time, several MENA countries are much affected by fluctuations in international commodity prices since they rely heavily on the export of non-fuel primary commodities. Conversely, because of heavy import reliance, many countries are vulnerable to fluctuations in price of foodstuffs. Furthermore, in countries heavily dependent on agricultural output and exports, economic performance remains vulnerable to weather conditions.

MENA has participated less in the globalization and integration of international capital markets than have Asian and Latin American countries. Capital flows into the MENA region have been small. Countries in the region have had almost no direct access to the capital markets of industrial countries, notwithstanding the growing incidence of joint ventures (domestic/foreign) following the liberalization of financial sectors in certain countries. The region has made only limited use of market-based income-hedging devices (such as product insurance and forward markets) despite its vulnerability to international price developments. Foreign direct investment (FDI) inflows to the MENA region have been lower than to other developing regions, except sub-Saharan Africa (Chart 5). During 1989-94, foreign direct investment inflows to the region amounted to about $10 billion, compared with a total of about $212 billion to the developing countries as a whole. In recent years, the completion of a number of oil- and gas-related investments in the GCC countries has been reflected in a reduction of FDI inflows. Portfolio flows into the region have remained low, because MENA countries have limited access to international capital markets and the region's capital markets are at the development stage. Private capital inflows have shown more diversity and response in countries that have made steady progress in macroeconomic and structural adjustment (such as Egypt, Israel, Jordan, Morocco, and Tunisia), as well as those recovering from domestic unrest (Lebanon).

Finally, on the structural front, in most MENA countries the public sector dominates domestic output. Its finances are the primary determinant of domestic liquidity and aggregate demand. On the other hand, it has been associated with economic distortions that have hindered productive efficiency and obfuscated the environment in which producers and consumers must operate. The public sector accounts for 30-60 percent of the labor force in most MENA countries and as high as 95 percent of the national labor force in some countries of the GCC. Public enterprises have had weak financial performance because they have been largely immune from competition and have suffered from organizational and managerial shortcomings, administrative controls, inappropriate pricing policies, and overemployment. Consequently, this sector has become dependent on government transfers and subsidies, placing a major burden on fiscal and monetary policies and lowering productivity in most MENA countries. Other structural constraints on investment and employment are evident in some MENA countries. The dominant role of public sector employment and its recruitment, job security, and wage-setting practices have led to segmented labor markets. Moreover, labor legislation in both public and private sectors has circumscribed the employer's scope for hiring, firing, or wage setting.

Macroeconomic and Structural Policies

The impact of these structural realities on recent economic performance has depended in part on the accompanying policy stance. In some cases, macroeconomic reform, singlemindedly implemented, has offset structural weaknesses. In other cases, inappropriate policies have accentuated them. To enhance productivity, several MENA countries have, in recent years, adopted structural reform measures to improve competition and better allocate resources. These measures included steps to free prices, reform public enterprises, liberalize the external trade system, and reduce exchange controls.

Several MENA countries (especially Algeria, Egypt, Jordan, the Islamic Republic of Iran, Morocco, Sudan, and Tunisia) made progress in liberalizing domestic prices during 1989-94. Direct controls have been gradually eased or removed on agricultural prices, producer prices in the manufacturing sector, retail prices, and distribution margins. Furthermore, partly reflecting concern about budgetary costs and waste, subsidies on a wide range of products have been reduced and their scope limited to essential consumer goods.

Several countries, with technical and financial assistance from the World Bank, launched public enterprise reform programs in the late 1980s. These programs sought to improve overall resource allocation, reduce the burden on government budgets, and limit the absorption of domestic and external financing by these enterprises. They were also directed toward increasing the administrative autonomy and accountability of public enterprises, improving their financial performance, and reducing their number through privatization, restructuring, or liquidation of nonviable firms. Implementation was slow in the initial stages as these reforms needed diagnostic studies to assess the financial viability of enterprises, amendments to the existing legal framework, and policy adaptations in other sectors. Nevertheless, a number of countries made progress. Algeria, Morocco, and Tunisia used management performance contracts, Egypt, Morocco, and Tunisia enacted related laws; and Egypt, Israel, Jordan, Kuwait, Morocco, Oman, Tunisia, and the United Arab Emirates engaged in partial or total privatization.

During 1989-94, several countries (including Algeria, Jordan, Morocco, and Tunisia) undertook comprehensive trade liberalization by reducing quantitative restrictions and lowering and rationalizing import duties. In general, the liberalization of imports of raw materials, intermediate products, and capital goods progressed faster than those of finished goods as the authorities sought to strengthen the ability of domestic industries to adjust to increased foreign competition. The reductions in tariff rates in some cases fell behind initial schedules because of budgetary considerations.

With a move toward a more outward-looking trade policy, these same countries took steps to ease foreign exchange controls, while Egypt, the Islamic Republic of Iran, and Sudan abolished multiple exchange rate systems, although the unification of exchange rates was subsequently reversed in the Islamic Republic of Iran and Sudan. The liberalization of foreign exchange controls on current account transactions, the strengthening of macroeconomic policies, and the implementation of comprehensive structural reforms enabled Israel, Lebanon, Morocco, and Tunisia in 1989-94 to make their domestic currencies convertible for current account transactions and to assume the obligations under Article VIII of the IMF's Articles of Agreement.

During this period, progress in liberalizing capital account transactions was slow in MENA countries. Nevertheless, several countries, including Egypt, Jordan, Morocco, and Tunisia, took steps to ease payments restrictions on capital transactions by residents and to liberalize rules governing the use by residents of foreign currency accounts in domestic banks. In general, nonresident capital transactions, involving repatriation of capital, dividends, and profits, have been made more liberal to encourage non-debt creating external financing and the transfer of technology.

The most important aspect of demand management policies has been the stance of fiscal policy, particularly the overall budget deficit and the underlying revenue and expenditure patterns. The MENA region has recorded fiscal deficits that are large by international standards, even though some countries have made progress in addressing fiscal imbalances. The central government fiscal deficit of 7 percent of GDP was more than double that of developing countries as a group. In oil-exporting countries, a sharp deterioration in public finances during 1989-91 occurred as oil prices fell. The higher fiscal deficits were initially financed by running down foreign assets, but subsequently addressed through the adoption of adjustment measures. Other countries in the region continuously improved their fiscal positions during 1989-94, and by 1994 both country groupings had reduced their fiscal deficit to about 5 percent of GDP. At the individual country level, Egypt, Israel, Jordan, Mauritania, and Tunisia tightened the stance of their fiscal policy substantially during 1989-94.

In addressing their fiscal imbalances, countries initially focused on cutting expenditures to bring about rapid improvement. In the second phase, they shifted toward enhancing revenue through improving tax systems and administration. In countries where adjustment comprised mostly cuts in expenditures, especially capital expenditure, fiscal tightening proved unsustainable and was quickly reversed. In contrast, countries that complemented expenditure restraints at an early stage by structural reform on the revenue side experienced more durable reductions in fiscal imbalances.

The overall objectives of tax reform were to simplify the tax system, increase its transparency, improve its buoyancy and elasticity, reduce its distortionary effects on the allocation of resources, and strengthen tax administration. To make direct taxation more efficient, a number of countries embarked on or continued efforts to simplify income taxation, and to broaden its base. With regard to indirect taxes, most reforms involved the replacement of various taxes and fees, imposed at various stages of production, by a value-added tax (VAT). Jordan introduced a general sales tax with a view to establishing a broad-based value-added type of tax. Morocco reduced the number of rates under the VAT, and Tunisia expanded its coverage to sectors previously excluded, such as wholesale trade activities. For social reasons, a few basic consumption goods were generally exempted from VAT. Egypt, Jordan, Morocco, and Tunisia made further progress in rationalizing and reducing tariffs. Meanwhile, tax administration was strengthened in most MENA countries through improvements in tax assessment and collection procedures, the reinforcement of tax auditing procedures, and increased use of computers.

With regard to monetary policy, broad money grew in 1989-93 in the MENA region as a whole, before declining in 1994. Similar trends were observed in both oil- and non-oil export countries, although the latter recorded larger monetary expansion (annual growth of broad money averaged 31 percent as compared with 11 percent in the oil-exporting countries), primarily reflecting financing requirements of fiscal deficits in a context of limited reserve funding.

Monetary policy was made more effective by changes in the financial system aimed at better mobilizing and allocating financial savings and strengthening the system of monetary control. First, the role of market forces in determining rates of return and credit allocation has been enhanced (Chart 6). Several countries made progress in liberalizing their rate structure, initially focusing on deposit rates, and in reducing the scope of preferential rates, especially for public enterprises. Second, the introduction of new instruments with market-determined rates broadened the menu of assets available to domestic savers. These instruments included certificates of deposits (Jordan), negotiable treasury bills (Egypt and Tunisia), and commercial paper (Morocco). Third, most MENA countries strengthened the financial system through recapitalization of financial institutions and improvements in prudential regulations and supervision. Fourth, new securities market laws were implemented with a view to improve trading, reporting, and accounting systems in capital markets.

To improve monetary control, especially in the context of financial liberalization, indirect instruments of monetary control began to replace quantitative credit restrictions. Several countries made rediscount mechanisms more sensitive to market conditions and used the sale and purchase of central bank paper and treasury bills more widely in the management of liquidity. They also made reserve requirements more uniform across financial institutions.

Exchange rate adjustments in the face of terms of trade losses in most MENA countries varied during 1989-94. Countries with flexible exchange rate arrangements underwent nominal effective exchange rate depreciations, but only Algeria, the Islamic Republic of Iran, Israel, and Tunisia experienced depreciations in their real effective exchange rates. Countries whose currencies were pegged to the U.S. dollar (except the Syrian Arab Republic) also had nominal effective exchange rate depreciations owing to the depreciation of the U.S. dollar. Reflecting their superior price performance, only the GCC countries experienced both nominal and real exchange rate depreciations. Among countries with currencies linked to the SDR or another basket of currencies, only Jordan had nominal and real exchange rate depreciations. Downward adjustments in real effective exchange rates compensated for worsening terms of trade in Algeria, Bahrain, the Islamic Republic of Iran, Israel, Kuwait, and Saudi Arabia, thus cushioning the impact of the terms of trade on domestic economic activity.

External Terms of Trade

The external environment in the MENA region has been particularly difficult in recent years. The cumulative deterioration in the region's terms of trade during 1989-94 amounted to 7.7 percent as compared with 1.8 percent for developing countries as a whole. Among developing countries, only sub-Saharan Africa registered worse terms of trade developments during the same period, while the Asian countries benefited from improvements in their terms of trade. In addition to a significant overall worsening, MENA countries have been subject to considerable fluctuations in their terms of trade--further undermining economic performance. The variance in the region's terms of trade was more than 15 times greater than that for developing countries as a group and 30 times greater than for industrial countries. Not surprisingly, oil-exporting economies faced the greatest variance in terms of trade within the MENA region.