Economic Recovery in MENA Region: The Path Ahead


B Rajesh Kumar


B Rajesh Kumar is an Associate Professor at Institute of Management Technology, Dubai. He obtained PhD from Indian Institute of Technology (IIT-Kharagpur). He has published over 25 empirical research papers in refereed journals and authored two books which includes a text book published by Mc Graw Hill Higher Education. His co authored research papers were cited in popular press like Financial Times UK, Economist.
Email: rajesh155_bk@yahoo.com

The world economic recovery continues, more or less along predicted lines. According to IMF Report World Economic Outlook 2011, the world economy is expected to grow at about 4.5 percent a year in both 2011 and 2012, but with advanced economies growing at only 2.5 percent while emerging and developing economies grow at a much higher 6.5 percent.

The main concern is that in advanced economies after an initial recovery driven by the inventory cycle and fiscal stimulus, the growth rate may fizzle out. On the other hand commodity prices have increased more than expected which indicates a combination of strong demand growth and supply shocks. In advanced economies, it has been predicted that there will be marginal effects on growth and core inflation in the context of share of oil, the disappearance of wage indexation and stabilization of inflation. The major concern in MENA region is the rising food and commodity prices. According to IMF, the recovery is broadly moving at two speeds, with large output gaps in advanced economies and closing or closed gaps in emerging and developing economies.

The MENA region can be said to have contained the global crisis and is in the path of recovery although economic growth varies widely across the region. Two major developments have hindered the path of recovery - the social unrest in the region and the surge in global fuel and food prices.

Higher commodity prices and external demand are boosting production and exports in many countries. Government spending programs are in the process of fostering recovery in many oil exporting countries in the region.

Some of the significant cyclical factors observed are the stronger than expected growth in demand for commodities during the second half of 2010 which drove oil prices for 2011 to about $90 a barrel by early 2011,up from the $83 a barrel expected in April 2010.

The spreading social unrest, rising sovereign risk premiums and increasing commodity import prices will act as constraints for growth in several MENA economies. There are also signs of increasing borrowing costs due to region wide repricing of risk. In the context of political turmoil, high unemployment and rising food prices, IMF estimates GDP growth rate of 4.1% and 4.2% for the MENA region in 2011 and 2012 respectively.

The group of Oil exporters in the MENA region is expected to witness GDP growth rate of 5% in 2011 with Qatar emerging as the fastest growing economy with a growth rate of 20% in GDP on account of continued expansion in natural gas production and large investment expenditure.
According to the IMF regional outlook report, for most oil exporters, the increase in oil prices from US$79 per barrel to US$ 107 per barrel will lead to higher growth in 2011. Average real GDP growth (excluding Libya) is projected to reach 4.9 percent in 2011 compared with 3.5 percent in 2010, while non-oil growth is projected to stay at 3.5 percent in 2011. For the GCC, growth is projected to reach 7.8 percent in 2011. GCC non-oil growth is set to accelerate by more than 1 percentage point to 5.3 percent in 2011. The oil exporters' combined external
current account surplus is estimated to increase from US$172 billion to US$378 billion (excluding Libya), and for the GCC from US$136 billion to US$304 billion.

The Saudi Arabian economy is expected to grow at 7.5% in 2011 compared to 3.5 per cent in 2010 primarily due to government infrastructure investment. Iran will have a stalled growth rate on account of phasing out of subsidies for energy and other products. Among the Oil importers of MENA region, Egypt is expected to witness a significant fall in GDP growth rate from 5.1 % to 5 % in 2011 due to disruptions to tourism, capital flows and financial markets. The growth rate of Sudan is expected to fall to 4.7%. The growth rate of the UAE is expected to hover around 3.3 per cent. The group oil importers economy is expected to slow down to 1.9% in 2011 compared to 4.5 per in 2010. Among the oil importers, the GDP growth rate of Tunisia is expected to fall by 2.4% compared to 2010. This can be attributed to the expected decline in tourism and foreign direct investment. Lebanon's GDP growth rate is expected to fall to 2.5% in 2011 compared to 7.5 % in 2010 which reflects the highest slowdown among all the oil importing MENA group of countries. Political uncertainty is hindering the growth of Lebanon's economy. Overall the Maghreb countries (Algeria, Mauritania, Morocco and Tunisia) excluding Libya is expected to witness modest slowdown in GDP growth rate 3.3% in 2011 compared to 3.5% in 2010. Higher prices for phosphate and iron ore have led to accelerated growth rates in Jordan , Mauritania and Morocco. Similarly the Mashreq group comprising Egypt, Jordan, Lebanon and Syrian Arab Republic will witness significant slowdown as economic growth rate is expected to fall to 1.5 per cent in 2010 as compared to 5 percent in 2010.

The IMF report cautions that social unrest in the Middle East and North Africa could place further upward pressure on food prices if the governments of large grain importers inside and outside the region step up their purchases to ensure sufficient supply in these subsidized domestic food markets.

Consumer price inflation is projected to increase to about 10 percent in 2011.The key driver of headline inflation is food prices, but core inflation is increasing in many countries. Key grain prices including those of corn and wheat have risen sharply reflecting heightened food security concerns. GCC Countries like Kuwait, Qatar, Saudi Arabia and UAE have to carefully monitor the impact of expansionary fiscal spending in order to check resurgence of inflationary pressures. Sudan has tightened monetary policy in response to inflationary pressures.

Current OPEC spare capacity levels, estimated at about 4½ percent of global demand, are sufficient to make up for losses of supply from Libya and to meet the expected increase in demand. The Middle East would also experience a large trade balance deterioration, by more than 0.4 percent of GDP in 2011.

The increase in the spreads for credit default swap and bonds could well translate into higher funding costs for corporations and governments. The current account surplus is projected to grow by 12.7% in the year 2011 for the entire MENA region. The Oil exporting group will witness a current account balance growth rate of 12.7%. At the same time the current account balances are showing a negative growth rate of 5.2 per cent for the Oil importing economies of the MENA region. The general government non-oil fiscal balance to non-oil GDP ratio is expected to deteriorate in Iraq, Kuwait, Oman, Saudi Arabia, Sudan, and Yemen.

For the financially developed economies of the GCC, the major focus ought to be the task of restoring capital and liquidity buffers used up during the crisis and improving the regulatory and supervisory regimes in tune with the global standards. These steps are essential in reviving the credit scenario particularly in the context of corporate defaults that happened in Dubai, Kuwait and Saudi Arabia. For the rest of the region, greater financial development could be achieved by removing barriers to entry and exit. Increasing numbers of nonperforming loans of banks in many non-GCC Countries like Algeria and Iran, is another area of concern in regions with social unrest.

The banking sector remains broadly sound in the GCC countries due to capital adequacy and particularly due to large government capitalization in countries like Qatar and United Arab Emirates. But there is a signal for potential risks particularly as evident from cases involving spillovers from nonbanking financial sector to the banking sector (Kuwait), and real estate sector (Bahrain, United Arab Emirates). Sovereign credit default swap spreads have widened in all GCC countries after the current crisis

It has been observed that credit to the private sector has picked up in several countries in 2010 in GCC countries, Algeria and Yemen. Equity markets across the MENA oil exporting region has fallen since January 2011. Rating agencies have downgraded Bahrain and Libya since the beginning of the unrest.

For the oil importers, the key policy challenges involve tackling the chronically high unemployment. For the oil exporters the focus ought to be on developing the financial systems and promoting economic diversification. Fiscal policy in the region has played a crucial role in cushioning the impact of the global crisis in the region. Focus on government investment programs particularly in infrastructure, would boost the domestic demand in oil exporting countries. Unfortunately the scope for fiscal maneuver in oil importing countries is constrained by a high level of debt in these countries.

The popular uprisings are basically as a result of a desire for greater political, social and economic freedom. The lessons from Egypt and Tunisia suggest that economic growth cannot be sustained unless they create jobs for the rapidly growing labor force accompanied by social policies. High unemployment is a long standing challenge for the oil importers of the MENA region. In 2008, unemployment rates in Egypt, Jordan, Lebanon, Morocco, Syria and Tunisia averaged 11 per cent which indicated the highest regional rate worldwide. The employment to working age population ratio in this region was also the lowest regional rate worldwide, at below 50 per cent. In most MENA countries a chronic case of unemployment among young people is basically a structural problem stemming from skill mismatches, labor market rigidities and high reservation wages.

Job creation was mainly in the private sector and mostly for expatriates in the GCC. Substantial skill mismatches and wage differentials could largely explain the low employment levels of nationals in the private sector. Unemployment among nationals is quite high in GCC countries like Oman and Saudi Arabia and Non GCC Countries like Algeria and Iraq particularly among youth.

Governments across the region are responding to the political event and rising prices through measures like expansions of fuel and food subsidies (Jordan, Kuwait and Tunisia), civil service wages, salaries and pension increases (Saudi Arabia, Sudan, Syria, Tunisia and Yemen), direct cash transfers (Kuwait and Bahrain). The size of the national fiscal packages in 2011 ranged from less than 0.5 per cent of GDP in some MENA oil importing countries to about 22 per cent of GDP in Saudi Arabia. In Bahrain and Oman, the newly created Gulf Development Fund is expected to provide an additional US$ 10 billion to finance housing and infrastructure costs.
Iran, Sudan and Yemen have initiated measures to enhance non oil revenues. The measures adopted by Egypt include a 15 per cent increase in government wages and pensions, the creation of a fund for reconstructing small enterprises and higher budgetary allocation for wheat imports. Iran has initiated substantial subsidy reforms. Jordan has raised allocations for social protection and announced cuts to taxes on fuel and foodstuffs, additional subsidies and increased civil service salaries and pensions. In Lebanon, reduction in income tax rates, increase in minimum wage, reduction of tax on gasoline (55 per cent), and full health coverage to civil service pensioners were the major initiatives. In Tunisia, the major initiatives included transfers to the unemployed, extended subsidies and scaled up public investments. These measures will lead to a higher cost of maintaining the existing subsidy system which averages to about 3 per cent of GDP in 2010. Morocco faces an increase in the cost of existing subsidies of about 2 per cent of GDP.

The social unrest in the Middle East highlights the need for the creation of a socially inclusive growth agenda. Inclusive growth can be achieved through fundamental economic reforms involving social policy, prudent fiscal management, governance, labour markets and business environment. Economic diversification ought to be an essential ingredient for the robust growth of the non oil sector. To facilitate this process, amendments in foreign direct investment (FDIs) rules, public private partnerships are essential. Efficient risk management practices ought to be in place to improve efficiency in the banking sector. Other significant steps include facilitating access to credit for small and medium sized enterprises, promotion of appropriate instruments for housing finance and development of domestic debt markets.
Continued unrest in the Middle East could adversely affect investor sentiments and the tourism sector to a great extent particularly in regions of Bahrain, Libya, Oman, Yemen. The current scenario in Libya already had spillover effects on the region through reduced remittances to Egypt and Tunisia. If the decline in equity prices persist, then recovery in real estate markets would definitely become problematic which would adversely affect the financial sector balance sheets.

The policies of the respective governments should focus on converting infrastructure investment into a source for employment generation. In this context, it is noteworthy to mention the relevance of youth oriented training programs such as Education for Employment Foundation which successfully operates in many countries like Egypt, Jordan and Morocco. Reforms are essential for the creation of a congenial business environment in terms of strengthened property rights, legislation and enhanced contract enforcement. Educational reforms have to aim for skill formation at lower levels.