The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF.
The economies of the Middle East and North Africa (MENA) region offer striking contrasts, with considerable variations in per capita income and underlying economic structures.1 Although most countries in the region are classified as middle-income economies with per capita incomes ranging from $1,000 to $7,000, Israel, Kuwait, Qatar and the United Arab Emirates are classified as high-income economies with an average per capita income of about $15,000, while Egypt and the Republic of Yemen-with per capita incomes below $1,000-are classified as low-income countries. Israel, Jordan, Lebanon, Morocco and Tunisia have more diversified economic structures than most countries of the region, which are characterized by a narrow production and export base, particularly the major fuel exporters-Algeria, the Islamic Republic of Iran and the countries belonging to the Gulf Cooperation Council (GCC).2
Because of their high dependence on mineral resources, most countries of the MENA region remain particularly vulnerable to adverse developments in their external environment (Table 1). For example, the terms of trade of all the major fuel producers have deteriorated by more than 50 percent since the reverse oil shock of 1986, which has complicated macroeconomic management and hampered economic performance. Furthermore, the reverse oil shock had important consequences for most of the other countries of the region, particularly those such as Egypt, Jordan, Lebanon, the Republic of Yemen and the Syrian Arab Republic, because a large share of their foreign-exchange earnings derives from the GCC countries in the form of workers' remittances. In addition, the regional crisis of the early 1990s triggered by Iraq's invasion of Kuwait resulted in a marked deterioration in the fiscal positions of several GCC countries while having a major impact on the flows of aid and workers' remittances to other countries of the MENA region.
Overall economic performance for the last decade and a half has been disappointing, in particular among fuel-exporting countries, where real per capita GDP fell by 20 percent on average from 1981 to 1995. The fall in per capita GDP coincided with weak oil-market conditions, the widening of fiscal and current account imbalances, and the accumulation of external debt. However, important progress has been achieved by a number of countries, particularly the more diversified exporters, in strengthening growth performance since the mid-1980s. In addition, most MENA countries have reassessed their economic-policy strategies and initiated reforms aimed at reducing internal and external imbalances while addressing structural weaknesses. The main challenge faced by most MENA countries in the period ahead is the intensification and sustained implementation of these reforms with a view to reaping the benefits of globalization and favorable regional developments.3
THE ADJUSTMENT EXPERIENCE
Most of the economies of the MENA region have suffered adverse exogenous shocks since 1986, including a terms-of-trade deterioration, several war and civil strife episodes, and, in the North African countries and Yemen, recurrent droughts. The nature, intensity and timing of these shocks, and the associated policy responses, have differed significantly among countries. The fuel exporters have been particularly vulnerable to movements in world oil prices, which, notwithstanding a temporary rise during 1990-91 as a result of the regional crisis, have remained subdued. The associated terms-of-trade deterioration and resulting macroeconomic instability were much more severe than those experienced over the same period by the MENA countries with more diversified economic and export bases.
Fuel Exporting Economies
MENA's fuel-exporting countries are heavily dependent on hydrocarbon export proceeds as a source of both foreign exchange and budgetary revenue, making these countries particularly vulnerable to fluctuations in world oil prices. Because of the relatively limited scope of the non-hydrocarbon sector and the narrow domestic tax base in most of these countries, budgetary revenue fell sharply from about39percentofGDP in 1981-85, to about 29 percent of GDP during 1986-90. Partly offsetting this revenue contraction, government spending declined by only about 2 to 3 percentage points of GDP over the same periods, mainly as a result of cuts in capital expenditure.4 The average fiscal deficit widened markedly from 1.5 percent of GDP in 1981-85 to 8 percent of GDP in 1986-90. In the early 1990s, the regional crisis resulted in a marked increase in public expenditure in some GCC countries. Because of a subsequent decline in budgetary revenue associated with falling oil prices, and notwithstanding a curtailment in public spending, budget deficits have remained excessive: an average of 9 percent of GDP for the group of fuel exporters in 1991-95. The economic implications of these fiscal imbalances have differed significantly between the GCC countries, on the one hand, and Algeria and Iran on the other, mainly because of the differing degrees of outward orientation and levels of foreign exchange reserves.
The GCC countries have traditionally pegged their currencies to the U.S. dollar and maintained their trade and payment systems free of current- and capital account restrictions. As a result, inflation in these countries was not affected by aggregate demand pressures stemming from the expansionary fiscal stance in the second half of the 1980s. These pressures, however, contributed to a substantial deterioration of the countries' external current-account position, which shrank from a surplus of 7 percent of GDP on average in 1981-85 to near balance in 1986-90.
In the first half of the 1990s, most of the GCC countries stepped up their efforts at expenditure restraint For instance, government spending in Saudi Arabia was reduced from 54 percent of GDP in 1986-90 to 44 percent of GDP in 1991-95. This reduction reflected broad-based cuts in expenditure, in particular outlays on services and supplies, operations and maintenance, and subsidies.5 These efforts, however, proved insufficient to bring down fiscal deficits to the low levels that had prevailed in the early 1980s. The persistence of large fiscal imbalances contributed to a shift of the external current account balance from a surplus to a deficit of about 10 percent of GDP on average in 1991-95. The increasing reliance on foreign savings to sustain public expenditure levels was associated with a substantial rise of external debt from 11 percent of GDP on average in 1986-90 to 37 percent of GDP on average in 1991-95. This increase would have been much higher had it not been for a shift in government borrowing. largely through a drawing down of foreign-asset positions of non-government residents. This contributed to a rapid buildup of public debt as a ratio to GDP, which, in the case of Saudi Arabia, has risen from about 50 percent to more than 80 percent over the last three years. This trend raises concerns as to the sustainability of the present fiscal stance and will require a strengthening of efforts to reduce primary deficit5 and improve growth performance through structural reforms.
In contrast to the GCC countries, the non-hydrocarbon sector has played a much more important role in the economies of Algeria and Iran. This has reflected in part the import-substitution strategy originally pursued by these two countries, whose populations and domestic markets are much larger than those of the GCC countries. The import-substitution policy also favored less open trade and payment systems than other MENA fuel exporters. This allowed Algeria and the Islamic Republic of Iran to avoid a significant deterioration in their current account positions despite the widening of their fiscal imbalances in the second half of the 1980s. On the other hand, demand pressures stemming from fiscal imbalances gave rise to substantial inflationary pressures that, despite pervasive price controls, translated into an increase in the rate of inflation from an average of 14 percent in 1981-85 to an average of 19 percent in 1986-90. The persistence of internal and external imbalances and the associated buildup of external debt prompted these two countries in the early 1990s to initiate some steps toward tighter demand management and to implement key structural reforms, including unifying exchange rates and liberalizing external current transactions. These efforts were undertaken in the context of an IMF-supported adjustment program in Algeria in 1991. They were undermined, however, by wage policies and, mainly as result of insufficient commitment to reform, could not be sustained for long.
The reimposition of an array of trade and exchange restrictions and a significant relaxation of fiscal and monetary policies in Algeria in 1992-93, as well as in Iran in 1993-94 in the context of a difficult external environment, had a detrimental effect on economic performance. Per capita income levels continued to decline while inflation increased to 25 percent on average in 1991-95. The deterioration compelled Algeria to formulate, in 1994, a more comprehensive program of macroeconomic stabilization and structural reform. This program, which has been supported by the IMF, has been predicated upon tight demand-management policies and wage restraint, as well as a realignment of relative prices, the removal of trade and payments restrictions, and the establishment of market mechanisms with a view to giving the private sector a greater role in the economy. As a result, the decline in economic activity has been arrested, and the fiscal deficit shrank from about 9 percent of GDP in 1993 to about 1 percent in 1995. Iran has also been able to reduce significantly its budget deficit in the last two years, which has contributed to a decline in inflation, but it has maintained trade and payments restrictions in the face of continued tight external constraints.
Diversified Exporters
The more diversified exporters form a rather heterogeneous group of countries that differ significantly with regard to the timing, comprehensiveness and consistency of their adjustment programs. Early on, Israel, Jordan, Morocco and Tunisia launched comprehensive programs of macroeconomic stabilization and structural reforms in the 1980s. These programs have been sustained over time, contributing to a reduction of both internal and external imbalances, as well as to a substantial overall improvement in economic performance. Egypt and Syria have also undertaken reforms, although later (early 1990s) and more gradually, while Lebanon and Yemen have only recently been in a position to start tackling their macroeconomic imbalances and structural weaknesses after protracted periods of civil strife and political instability that severely impaired economic-policy foundation and disrupted economic activity.
During the 1970s, Israel, Jordan, Morocco and Tunisia pursued an inward-oriented development strategy characterized by pervasive government controls and lax financial policies. The strategy proved unsustainable in the early 1980s as both internal and external imbalances widened. Failure to restrain public expenditure in the face of declining revenues resulted in a significant widening of their fiscal deficits, which averaged over 14 percent of GDP during 1980-85. Growing fiscal imbalances contributed to both rising inflation and a worsening in their external positions: external debt burdens reached more than 90 percent of GDP on average during the first half of the 1980s. In response to this deterioration, Morocco, Tunisia and Israel, and later Jordan, their policy strategy in the second half of the 1980s and tried to redress their fiscal positions and reduce government absorption, first by restraining both current and capital expenditure. then in a second stage by reforming their tax systems. These tax reforms entailed widening the tax base, improving the elasticity of tax systems, and introducing less-distortionary taxes, including the value-added tax (Israel, Morocco and Tunisia) or a general sales tax (Jordan). They have led to a steep decline in budget deficits from an average of 14 percent of GDP in 1981-85 to about 5 percent in 1986-90 and 3 percent in 1991-95. The reforms were complemented by the introduction of market-oriented treasury debt instruments, which allowed for an increased reliance on non-inflationary sources of deficit financing. The improvement in fiscal positions has been supported by non-accommodating monetary policies and has allowed a shift in credit to support private sector activity.
These policies contributed to a substantial decline in inflation, especially in Israel where the rate of inflation fell from an average of over 200 percent a year during 1981-85 to under 25 percent during 1986-90 and 13 percent in 1991-95. In Jordan, Morocco and Tunisia, average inflation fell from 9 percent in 1981-85 to about 6 percent in 1986-95. In addition to their anti-inflationary fiscal and monetary policies, broadly flexible exchange-rate policies enabled them to address a deterioration of their average terms of trade of about 12 percent from 1986 to 1995 and prevent any significant misalignment of real exchange rates.
On the supply side, all four countries have taken wide-ranging actions to liberalize the incentive structure and reform the regulatory framework. Important steps have been taken to liberalize foreign trade, which was critical for the promotion of exports and efficient import substitution, in particular by virtually abolishing quantitative restrictions and reducing effective protection. Israel, Jordan, Morocco and Tunisia have also made significant progress in decontrolling domestic prices, thereby enhancing the positive effects of trade liberalization on resource allocation. Ambitious privatization programs have been launched (Jordan, Morocco and Tunisia) to widen the scope for private-sector activity and help reduce the burden of public enterprises on government finances. The financing of private sector investment has been facilitated by the implementation of financial-sector reforms. Interest rates have been largely deregulated and compulsory credit-allocation schemes eliminated, while banking legislation has been modernized and prudential standards brought closer to international norms.
The substantial reduction of internal imbalances and the liberalization of the incentive structure have enabled these countries to attain external current-account convertibility while at the same time allowing for the accumulation of foreign exchange reserves. In addition, some progress with the phasing out of restrictions on longer-term capital-account transactions has helped to attract private foreign investment
After falling from 19 percent of GDP in 1981-85 to 17 percent in 1986-90, private investment rebounded to 21 percent in 1991-95. There was also a substantial increase in the efficiency of investment, as reflected in the decline of the incremental capital-output ratio from over 7 percent on average during 1981-85 to 5.5 percent during both the 1986-90 and 1991-95 periods. Consequently, economic activity accelerated significantly, with real GDP growth increasing from 3.5 percent a year in the first half of the 1980s to almost 5 percent in 1991-95. This translated into a more limited, albeit significant, increase in the growth of per capita income from 1.1 percent a year in 1981-85 to 1.7 percent in 1991-95, reflecting in part the impact of the large number of Palestinian workers who returned from the GCC countries to Jordan following the Persian Gulf War and of emigrants from the former Soviet Union who moved to Israel.
Egypt and Syria undertook steps to liberalize their economies in the early 1990s, following several decades of extensive public ownership in most areas of economic activity and inward-oriented trade policies. Nevertheless, the public sector still plays a pervasive role in both countries, not only in the hydrocarbon sector but also in industry, where public enterprises account for more than two thirds of output.
In the second half of the 1980s, Egypt faced large macroeconomic imbalances, including an average budget deficit of 18 percent of GDP, an average inflation rate of about 20 percent, and an external debt of more than 90 percent of GDP. Following several attempts at tackling these imbalances and liberalizing the economy, Egypt embarked, in 1991, on a program of macroeconomic stabilization and structural reform supported by the IMF. Under this program substantial progress in fiscal adjustment was achieved, coupled with a strengthening of the budget through the introduction of a general sales tax and a global income-tax reform, and significant efforts at expenditure restraint Reflecting these measures, as well as higher oil revenues and Suez Canal receipts, the fiscal deficit declined steadily from 17 percent of GDP in 1990-91 to less than 2 percent of GDP in 1994-95,contributing to a decline in the rate of inflation to about 9 percent in 1994-95. The intensified adjustment efforts from 1991 onward, combined with debt relief granted in 1990-91 and a surge in capital inflows beginning in 1991-92, have also resulted in substantial accumulation of external reserves. Egypt has also undertaken a number of structural reforms toward liberalizing the trade system, eliminating input and consumer-goods subsidies, and privatizing public-sector companies. Nevertheless, real per capita GDP has declined steadily since the early 1990s, owing to weaknesses in private- sector activity and low investment
Since the early 1990s, Syria's ongoing transition from a tightly regulated economy dominated by the public sector to a market based economy driven by the private sector has centered on promoting private investment, foreign trade, a more realistic pricing of foreign exchange and increased price flexibility. The realignment of relative prices has induced a strong supply response and a significant improvement in growth performance, with output growing an average of 7 percent a year during 1991-95. Syria's liberalization efforts, however, have not been backed by sufficient fiscal adjustment High public expenditure resulted in budgetary pressures that were intensified by the drying up of external financing following the 1990-91 regional crisis and the weakening of oil prices. Thus, the fiscal balance shifted from a surplus of about 2 percent of GDP in 1992 to a deficit of about 4 percent in 1995. The associated aggregate demand pressures have contributed to a deterioration of the external current account position from a surplus of8 percent of GDP in 1991-92 to a deficit of 3.5 percent of GDP in 1993-95.
In recent years, economic difficulties in Yemen have been exacerbated by a sharp decline in external assistance and worker remittances following the breakup of the former Soviet Union and the Gulf War and also by a terms-of-trade deterioration. Civil strife, in the wake of the country's unification, limited the government's capacity to respond to these external factors and burdened the economy with rehabilitation costs. The resolution of the political conflict in late 1994 was quickly followed, in 1995, by determined actions to adjust the course of demand management policies and initiate structural reforms. These initial measures were reinforced by the formulation, for 1996, of a comprehensive adjustment program incorporating forceful stabilization policies and a broad set of far-reaching structural reforms. This program aims at achieving higher growth in the non-hydrocarbon sector while quickly reducing inflation and progressing toward the restoration of external-sector viability. The core policy actions recently initiated emphasize a further realignment and liberalization of relative prices, including the exchange rate and interest rates, a substantial tightening of the fiscal stance, a major liberalization of the trade and payments system and an aggressive privatization program.
Lebanon’s 15-year civil war (1975-90) exacted a heavy toll in both human and economic terms. Per capita income is estimated to have fallen by more than efforts centered on a nominal exchange-rate anchor that resulted in a sharp decline in inflation and an accumulation of foreign exchange reserves to comfortable levels. Besides the need to finance a large reconstruction program, further reduction in the budget deficit will be necessary to reach the authorities' stabilization objectives.
CHALLENGES FOR THE PERIOD AHEAD
The MENA region has considerable natural, human and financial resources; it is strategically located, has longstanding economic and financial links with industrial countries, and has considerable trading skills. To realize more fully this potential, there has been a broad reassessment by all MENA countries of their economic strategies toward attaining high and sustainable growth. Consequently, the focus has turned to achieving both a more stable macroeconomic environment and more efficient resource allocation.
So far, the progress toward these objectives has varied substantially among countries with regard to the timeliness, depth and consistency of adjustment policies. The challenges for the period ahead are bound to vary significantly among countries in accordance with these differences and the results of pa.st adjustment efforts. In addition, they will also depend, to an important degree, on future developments in the external environment, including, in particular, 1) the prospects for concluding a just, comprehensive and durable Arab-Israeli peace;6 2) the 50 percent during that period. The end of the hostilities in 1990 and the restoration of political stability allowed for concerted economic policies to ensure a sustainable recovery of the economy. In addition to a pickup in real GDP growth, stabilization opportunities for a closer integration with the European Union under the Mediterranean Basin Initiative;7 3) the economic outlook in industrial countries; and 4) the evolution of world hydrocarbon prices, which could be subject to significant downward pressures as a result of developments in the republics of the former USSR and Iraq's possible return to the oil market.
Current projections indicate the continuation of a relatively moderate expansion of economic activity in industrial countries and point to a rather subdued outlook for oil prices over the next two years. Nevertheless, the short-term outlook for the MENA region is expected to improve. Real GDP growth should average about 3.5 percent in 1996-97, allowing for gains in per capita incomes of 1 percent a year. Concurrently, average inflation is expected to slow down to 6.5 percent while the external current account should narrow to 1.5 percent of GDP by 1997. To realize these projections and strengthen their potential for achieving sustainable economic growth, all MENA countries will need to act forcefully to address the macroeconomic imbalances and structural weaknesses that have limited saving and investment.
Table 1. Middle East and North Africa: Revenue from Mineral Resources |
||
(In percent of total revenue) |
||
Country |
Government Revenue |
Export Revenue1,2 |
Algeria |
58.6 |
78.9 |
Morocco |
0.8 |
9.86 |
Bahrain |
63.2 |
29.33 |
Oman |
72.9 |
87.86 |
Egypt |
29.54 |
10.4 |
Qatar |
69.6 |
75.36 |
Iran |
58.3 |
73.4 |
Saudi Arabia |
74.8 |
74.5 |
Israel |
--- |
--- |
Syria |
15.9 |
34.6 |
Jordan |
0.3 |
6.85 |
Tunisia |
5.4 |
7.9 |
Kuwait |
68.16 |
53.26 |
U.A.E. |
79.1 |
52.76 |
Lebanon |
--- |
--- |
Yemen |
28.2 |
43.4 |
11993-94 averages, unless otherwise indicated. |
||
2 Exports of goods and services plus worker remittances. |
||
3 1992 average. |
|
|
4 Including Suez Canal receipts. |
|
|
5 1992-94 average. |
|
|
6 1992-93 average. |
|
First, significant fiscal imbalances remain in many countries, especially among the GCC members, where they have contributed to both large external-account deficits and mounting public debt in recent years. Fuel-exporting countries need to broaden their domestic tax base, in part through the adoption of broad based domestic taxes to reduce the dependence of budgetary revenues on hydrocarbon earnings. Similarly, among the more diversified exporters, Lebanon, Syria and Yemen would benefit from adopting broader based domestic taxes, while Jordan, Morocco and Tunisia would need to strengthen alternative revenue sources with a view to compensating for the losses in trade taxes that are expected to result from the implementation of the agreements with the European Union. On the expenditure side, certain MENA countries should aim at better targeting their remaining generalized subsidies to the most vulnerable population groups and at strengthening public education to reduce poverty and facilitate integration into the world economy. This should be accompanied by civil-service reform to reduce the government wage bill and improve the efficiency of government operations. The prospects for a broadening of the peace process between the Arab countries and Israel should also increase the scope for significant reductions in defense spending over time.
Second, MENA countries will need to intensify privatization programs to revitalize their manufacturing sectors and limit government operations to the efficient provision of public goods. While tangible progress has already been achieved in some countries, such as Morocco, the need for promoting the role of the private sector is particularly pressing for Algeria, Egypt, Iran and Syria, where industrial sectors remain largely dominated by public enterprises.
Third, stepped-up efforts are also needed to scale back regulations and remove distortions in both goods and factor markets to improve the efficiency of resource allocation. The external trade and payments systems of several MENA countries are still saddled with restrictions, including excessive tariffs and pervasive quantitative restrictions. While economies of the GCC are relatively open, trade reform is needed in several other countries, such as Egypt, Iran and Syria For Israel, Jordan, Morocco and Tunisia, which have already committed to join a free trade area with the European Union, dismantling trade barriers vis-a-vis third countries will help to minimize the cost of trade diversion. Regarding factor markets, measures must be adopted to facilitate labor mobility within certain countries and within the region, and to maximize the creation of employment opportunities for a rapidly growing labor force in most MENA countries. Moreover, further steps should be taken to strengthen financial intermediation in most non-GCC countries, through the removal of controls on rates of return and credit allocation (particularly in Iran and Syria) the promotion of greater competition among financial institutions and the strengthening of prudential regulations.
Fourth, there is a need for greater diversification of the non-hydrocarbon export base, which remains too narrow in most MENA countries and excessively vulnerable to adverse terms-of-trade movements. Such a need is particularly acute for countries such as Algeria, Egypt, Iran and Syria, which have the capacity to develop strong export-driven growth strategies.8 The latter two countries would also benefit from a further liberalization of their foreign-exchange markets. Beyond these structural measures, sustaining reform programs will require a stable macroeconomic environment with consistent fiscal, money and exchange rate policies.
* The authors would like to thank Mohamed El-Erian and Karim Nashashibi for helpful comments. An earlier version of this article appeared in the IMFs World Economic Outlook. May 1996.
1 The coverage of MENA in this paper includes the economics of the Middle East country grouping used in International Financial Statistics plus the three North African countries of Algeria, Morocco, and Tunisia. Iraq and the Libyan Jamahiriya, however, are excluded from the analysis because of data limitations.
2 Fuel exporters arc defined as countries whose fuel exports account for over SO percent of total exports of goods and services plus workers' remittances. The GCC includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. Although Bahrain docs not technically meet the above definition of fuel exporters, it is closely interconnected. and has many similarities with other GCC countries and is therefore included among the group of fuel exporters for the present analysis.
3 Recent analyses of macroeconomic and structural issues in the MENA region are also provided in Mohamed El-Erian and Sharnsuddin Tareq, "Economic Reform in the Arab Countries: A Review of Structural Issues," in Economic Development of Arab Countries, ed. by Said El-Naggar (Washington: International Monetary Fund, 1993), pp. 26---50; International Monetary Fund, Macroeconomic of the Middle East and North Africa: Exploiting Potential for Growth and Financial Stability (Washington, 1995); and The World Bank, Claiming the Future: Choosing Prosperity in the Middle East and North Africa (Washington, 1995).
4 The decline in expenditure was more pronounced in the case of the Islamic Republic of Iran, largely as a result of the cessation of the war with Iraq in 1988.
5 Kuwait, however, sharply increased its government expenditure from 55 percent of GDP in 1986--90 to about 100 percent of GDP in 1991-95, mainly for reconstruction following the Persian Gulf crisis.
6 See Said El-Naggar and Mohamed El-Erian, "The Economic Implications of a Comprehensive Peace in the Middle East," in The Economics of the Middle East Peace, ed. by Stanley Fischer, Dany Rodrik, and Elias Tuma (Cambridge, Massachusetts: MIT Press, 1993).
7 For more details see Saleh Nsouli, Amer Bisat, Oussama Kanaan, "The European Union's New Mediterranean Strategy," Finance and Development, Vol. 33, September 1996.
8 For an analysis of the sources of comparative advantage in these countries, sec The World Bank, "Claiming the Future," pp. 65-7.
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