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Editor: Zubair Iqbal
©2001 International Monetary Fund
Part I. Selected Macroeconomic and Financial Issues |
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Economic Challenges in the Middle East and North Africa—An Overview Zubair Iqbal During the past decade, progress has been made in the Middle East and North Africa to strengthen macroeconomic stability and establish the preconditions for sustained rapid growth.1 Most countries have also made cautious progress with structural reforms, including trade liberalization and privatization. Tables 1–5 summarize the evolution of the region's economies during the past decade. Several economies—including Algeria, Egypt, Jordan, Morocco, Pakistan, Sudan, and Yemen—have implemented macroeconomic adjustment programs, supported by the use of resources from the International Monetary Fund. During the second half of the 1990s, there was a general deceleration in inflation as the national authorities, by and large, tightened monetary policies and as fiscal deficits were reigned in, while world prices of most imports were subdued. At the same time, external current account deficits fell in response to generally tightened demand management and in some cases corrections in exchange rates. In keeping with the containment of external current account deficits, external debt (as a percentage of exports of goods and services) remained broadly unchanged for most of the economies in the region. However, the growth of real GDP generally remained weak, while population continued to grow briskly (although more slowly than in the past), and foreign direct investment inflows were well below those in other regions.2
Progress in implementing reforms has varied among countries. Before the 199798 downturn in oil prices, the major oil-exporting countries responded to episodes of falling oil prices with a combination of financing and adjustment. Substantial external reserves and the low level of public debt allowed room to finance external current account and fiscal deficits. Adjustment was largely undertaken through cuts in capital outlays, which also adversely affected private-sector growth and did not correct the underlying structural weaknesses of the economy. The adjustment strategy during these earlier episodes of declining oil prices thus did not seek a lasting solution, which would have reduced fiscal vulnerability to oil revenue fluctuation. The strategy instead was predicated on the assumption that oil prices would recover and stabilize at a higher level. The oil price downturn of 199798 spurred a policy response that sought to fundamentally reform underlying structural distortions—not only to deal with the short-term adverse effects of fluctuating oil export receipts, but also to establish a firm foundation for reducing dependence on oil and facilitating sustained growth of the non-oil sector. Although fiscal consolidation through rationalization of expenditure and mobilization of non-oil revenues is deemed to be the central plank of this reform strategy, attention is also being paid to narrowing the role of the government sector—through public-sector restructuring and privatization, correcting prices of officially supplied inputs to reduce implicit subsidies, strengthening the financial sector's ability to mobilize and allocate savings more efficiently, and introducing regulatory reform to encourage the foreign direct investment that will deepen and diversify the economic base. A number of oil-producing countries have initiated steps to implement this adjustment strategy. The experience of non-oil-exporting countries has been much more diverse. Recent initiatives toward reform have included policy measures to ensure macroeconomic stability, attract foreign direct investment, increase exports, and create favorable conditions for private-sector growth based on new technologies and improved labor skills. The European Union's Association Agreements with countries of the southern and eastern Mediterranean to establish free trade in industrial products have played a catalytic role in facilitating the needed structural reform in a number of countries. The Greater Arab Free Trade Agreement was launched in 1997 to establish free trade among its 18 signatories over a ten-year period. It aims at an up-front elimination of quantitative restrictions on trade and annual reductions in tariffs by 10 percent. The effort has, however, been constrained by concerns about the potential short-term social consequences of a quick reform of the existing widespread structural distortions. The resulting gradualist policy stance has slowed the pace of trade liberalization and integration with the global economy.3 And the consequent slow pace of improvements in production efficiency may have contributed to the modest inflow of foreign direct investment and kept growth largely import substituting rather than outward oriented. Challenges for the Future Important challenges remain. Economic growth needs to be accelerated to accommodate the rapidly expanding labor force and alleviate mounting unemployment. Although the rate of population growth has slowed, the labor force is projected to increase rapidly in the medium term. During the past several years, productivity has stagnated, resulting in little increase in per capita output, and real wages also have stagnated. The fight against poverty remains daunting. Demographic changes have also been associated with an increased concentration of unemployment in rapidly expanding urban areas. Conversely, investment has grown only modestly. There is a broad consensus in the region on the need for a structural reform strategy to improve resource allocation and create institutional conditions suitable for accelerated growth while maintaining internal and external stability. Such a strategy would include further reducing fiscal deficits, increasing exchange rate flexibility, and liberalizing trade policy—supported by decontrolling prices, privatizing state-owned enterprises, and encouraging investment, especially foreign direct investment. Strengthening rules to ensure private property rights and increasing the number of activities in the private sector have come to be accepted as essential building blocks of such a strategy. In particular, there has been a recognition of the need for early reform of the financial sector—especially stronger prudential regulation and supervision—as a precondition to reap the full benefits of reform undertaken in the other areas, significantly raise the levels of domestic savings and investment, and thus promote higher growth and employment generation (IMF, 1997). Appropriately sequenced capital account liberalization has also been recognized as desirable to promote foreign direct investment (Chabrier, 1998). However, the preferred gradualist approach to reform in the region, in combination with the more and more challenging external environment, may be adversely affecting prospects for an early acceleration of growth. This book brings together a number of papers prepared by IMF staff during the past few years on some of the region's major structural and macroeconomic issues, with which its governments are grappling. By identifying specific policy imperatives in particular countries or groups of countries with a broad relevance to the entire Middle East and North Africa region, the book aims to reinforce the importance of structural reforms—in combination with macroeconomic stability and market-based prices—in promoting self-sustaining growth. The book is divided into two parts: one dealing with selected macroeconomic and financial issues, and one addressing external policies. Selected Macroeconomic and Financial Issues Part I consists of six chapters and one addendum that focus mainly on macroeconomic and financial-sector issues. In Chapter 2, "Demographic Transition in the Middle East: Implications for Growth, Employment, and Housing," Dhonte, Bhattacharya, and Yousef emphasize that the working-age population is expected to grow faster in the Middle East than in any other region of the world between 2000 and 2015, rising annually by 2.7 percent. This demographic explosion presents the region with a major challenge: to provide jobs, adequate incomes, and housing for the growing population. However, the chapter argues that the expanding labor force can also be seen as an opportunity to generate higher per capita income growth on a sustainable basis. It stresses the importance of market-friendly institutions and policies in turning this challenge into opportunity. In addition to improving the enforcement of property rights and increasing total factor productivity, the emerging situation will call for, among other things, steps to promote investment, including foreign direct investment; restore appropriate exchange rates; liberalize trade; introduce market-clearing domestic prices; and reform the financial sector, in an environment of macroeconomic stability. In Chapter 3, "Determinants of Inflation in the Islamic Republic of Iran—A Macroeconomic Analysis," Liu and Adedeji develop a macroeconomic framework for analyzing the major determinants of inflation in Iran during the period 1989/901999/2000. The chapter was inspired by mounting evidence that persistent macroeconomic disequilibria in many regional economies have been associated with expansionary financial policies, while correction of exchange rates has been resisted through intensified controls (including administered prices). In the event, inflationary pressures have persisted, resulting in weaker growth. An empirical model for Iran is estimated by taking into consideration disequilibria in markets for money, foreign exchange, and goods. The model estimation shows that excess money supply generates an increase in the rate of inflation, which in turn intensifies asset substitution (from money to foreign exchange), thereby weakening real demand for money and exerting pressures on the foreign exchange market. The authors call for sustained, prudent monetary policy to reduce inflation and stabilize the foreign exchange market. In Chapter 4, "Financial Liberalization in Arab Countries," Nashashibi, Elhage, and Fedelino note that the substantial progress in financial liberalization in a number of Arab countries has placed them on a more solid macroeconomic footing, which has been associated with fiscal adjustment efforts and structural reforms—often as part of an IMF-supported program. However, much of the progress has focused on the banking sector and the conduct of monetary policy. Conversely, capital markets have remained undeveloped, with limited integration with the international markets. This is particularly the case for most non-oil-exporting Arab countries, where controls on capital movement remain. Moreover, the authors note that—given the limited size and depth of domestic financial markets—available domestic financing in some countries has fallen short of their developmental needs. The chapter therefore stresses the need to promote domestic equity and bond markets and to encourage foreign direct investment to provide the much-needed financing for productive activities. It emphasizes the crucial role of good macroeconomic and growth performance, trade and capital liberalization, and well-functioning financial institutions as important prerequisites to attract external private inflows and to integrate domestic capital markets into global markets. During the past several years, Islamic banking has grown rapidly in the region. It has led to financial innovation, necessitating changes in central banking operations, diversification of money markets, the establishment of more rigorous accounting and disclosure standards, and strengthened supervision. In Chapter 5, "Monetary Operations and Government Debt Management Under Islamic Banking," Sundararajan, Marston, and Shabsigh outline recent progress in developing Islamic financial instruments for the management of monetary policy and public borrowing requirements. The chapter provides details on new instruments that have been under development in Iran and Sudan. The authors touch upon the institutional arrangements for interbank market operations and the design of effective central bank credit facilities that are needed under the Islamic banking to support these new instruments. They emphasize that the unique challenge of implementing market-based monetary policy operations in the Islamic banking system derives from the complexity of designing market-based instruments for monetary control and government financing that satisfy the Islamic prohibition on ex ante interest payments. This challenge can limit the development of efficient mechanisms for monetary control and general government funding, and thus perpetuate reliance on direct controls. These inefficiencies should be addressed by creating new instruments to avoid disintermediation and persistent inflationary pressures. In his addendum to Chapter 5, "Recent Developments in Islamic Banking," Shabsigh looks at progress made in the past four years, particularly in the development of financial instruments, in central banking operations, and in the regulatory and institutional areas to address the issues noted above. In Chapter 6, "Fiscal Sustainability with Nonrenewable Resources," Chalk addresses crucial issues confronting economies that depend on resources such as oil and gas for much of their exports and budgetary revenues. Apart from the intergenerational equity implications of the finite nature of such resources, the national authorities are confronted with the difficult task of adjusting government spending to fluctuations in resource-related revenues, while cushioning the nonresource (domestic) economy from the effects of these fluctuations. Chalk develops—in a simple dynamic framework—an alternative fiscal behavior in an economy where wealth is derived predominantly from a nonrenewable resource such as oil. The chapter highlights the structural weaknesses in the underlying budgetary position, takes into account the rate of depletion of a country's natural resource base, and examines the effects of changes in a country's terms of trade in order to develop an alternative indicator of fiscal sustainability. When the budget is strongly influenced by natural resource income subject to exogenous shocks, the situation of the budget rather than the level of the deficit has important implications for sustainability. The chapter therefore notes that, rather than the traditional deficit-GDP ratio as an indicator of fiscal health, fiscal sustainability in resource-dependent economies should be measured by the "core" deficit, which is defined as the overall deficit less net transfers and resource-based and investment income. A higher core deficit leads a country further away from long-run sustainability. The chapter stresses the importance of a country's terms of trade for the conduct of fiscal policy; under improving terms of trade, a large resource endowment can act as a substitute for fundamental fiscal reform. However, such policies could be disastrous if the terms of trade worsen over an extended period. Chalk demonstrates that to provide for future generations, governments need to have a strong commitment to replace their nonrenewable resource wealth with financial assets. More recent work in this field has encouraged the establishment of savings and stabilization funds from oil export receipts as a means to achieve the twin objectives of intergenerationally distributing oil wealth and of countering the adverse effects of falling exports and budgetary receipts on government spending, and thus on the growth of the non-oil economy (see Valdés and Engel, 2000; Fasano, 2000). External Policies There has been an increased recognition in Middle Eastern and North African countries of the role played by external policies, particularly exchange rate policies, in achieving and maintaining competitiveness, and thus balance of payments viability, which is critical for sustained growth. This has been manifested in important steps toward reform of the exchange and trade systems during the past few years, which are examined in the six chapters and two addenda of Part II. In Chapter 7, "External Stability Under Alternative Nominal Exchange Rate Anchors: An Application to the Gulf Cooperation Council Countries," Erbas¸, Iqbal, and Sayers suggest that the estimated import and export elasticities would imply little improvement in external stability by shifting from an effective peg to the U.S. dollar to the SDR. In some cases, the authors note, stability may actually not be improved by switching from a dollar peg to an SDR peg. Effective pegging to the dollar has been guided by the broad objective of minimizing exchange risks for the private sector and ensuring stable exchange rates among Gulf Cooperation Council (GCC) member countries. In late 2000, the GCC countries decided to formalize a common peg to the dollar as an initial step toward a possible common currency area in the future. In Chapter 8, "Real Exchange Rate Behavior and Economic Growth in the Arab Republic of Egypt, Jordan, Morocco, and Tunisia," Domaç and Shabsigh examine the effects of real exchange rate misalignment on the collective economic growth of these countries. They argue that misalignment, among other things, can lead to a reduction in economic efficiency, a misallocation of resources, and capital flight. Correction of the real exchange rate, combined with appropriate demand management, is required to restore macroeconomic equilibrium. Three measures of misalignment are constructed for Egypt, Jordan, Morocco, and Tunisia to test the hypothesis. They include measures based on purchasing power parity, on a black-market exchange rate, and on a structural model. The empirical results confirm that misalignments stemming from exchange rate policies in these countries had adverse effects on their economic growth during the period 197090. The authors note that the liberalization and economic reform policies initiated by these countries in the late 1980s and 1990s have resulted in major realignments of their real exchange rates, which—if pursued in a sustained fashion—could enhance their growth prospects. In Chapter 9, "Exchange Rate Unification, the Equilibrium Real Exchange Rate, and the Choice of an Exchange Regime: The Case of the Islamic Republic of Iran," Sundararajan, Lazare, and Williams illustrate how economic policy variables and exogenous shocks affect the real exchange rate primarily through the fiscal balance and, consequently, the savings-investment gap. By assessing developments before the steps initiated in 1999/2000 toward exchange system reform, the authors emphasize that the appropriate level of the real effective exchange rate and its medium-term path depend upon the mix of monetary, fiscal, and structural policies that underpin the evolution of inflation, balance of payments, and productivity growth. They note that there has been a large variability in the real exchange rate, which reflected the corresponding variability in both domestic (fiscal deficits and inflation) and external (real price of oil and terms of trade) factors. The reduction in inflation is viewed by the authors of Chapter 9 as critical to sustaining competitiveness and growth. They contend that the pursuit of the dual objectives of reducing inflation and maintaining appropriate real exchange rate targets can best be achieved by a managed-peg regime or by managed fixing with a sufficiently wide band around the central parity. Implementing such a mechanism would require eliminating multiple exchange rates, consolidating fiscal accounts within a medium-term framework, adopting more flexible market-based instruments of monetary policy that are consistent with declining inflation, and relaxing exchange controls. The proposed exchange regime should be managed by setting up indicators and operating targets by developing progressively more market-based instruments of exchange market intervention. In the addendum to Chapter 9, "Exchange System Reforms in the Islamic Republic of Iran: A Note on Past and Current Practices," Shabsigh describes steps taken by the national authorities, effective in 1999/2000, to reform the exchange system. The number of multiple rates has been reduced, and the market-based Tehran Stock Exchange Rate (TSE rate) has been allowed to depreciate significantly in line with market conditions. Concurrently, fiscal and monetary policies have been tightened, laying the groundwork for successful exchange reform toward unification. Meanwhile, although apparently managed on a day-to-day basis by the Central Bank of Iran in the form of a crawling-band regime, the TSE rate has remained broadly market determined. In Chapter 10, "Export Performance and Competitiveness in Arab Countries," Nashashibi, Brown, and Fedelino note that the export performance of Arab countries since the 1980s has been mixed. Even though non-oil-exporting countries have improved their product diversification, their market share in world imports did not keep pace with growth in world trade during the 1990s. Analysis based on real effective exchange rates implies some loss of competitiveness. At the same time, weaker macroeconomic policies and the adoption of fixed exchange rates in a number of countries also resulted in real effective appreciations. Although financial stability was improved because of fixed exchange rates, the fixed rates contributed to higher real interest rates, reducing investment and diverting savings toward financial assets. In the period ahead, without significant productivity gains, the combination of the current policy stance would add further pressures on competitiveness, especially for non-oil-exporting countries. The authors of Chapter 10 emphasize that improvement in competitiveness will depend crucially on the pace at which the economies and trade regimes are liberalized, so that market signals improve resource allocation. Accelerating privatization and creating a friendlier environment for foreign direct investment would provide the much-needed technology and managerial skills to facilitate productive growth. These initiatives would benefit from the adoption of more flexible exchange rate regimes supported by structural reforms, so as to enhance the supply responsiveness of the economy. To expand the size of their markets and access to capital and technology, and thus promote growth, several countries of the southern and eastern Mediterranean have entered into Association Agreements with the European Union (AAEUs). In Chapter 11, "The Impact of European Union Association Agreements on Mediterranean Countries," Ghesquiere evaluates the economic benefits and costs of AAEUs for Egypt, Jordan, Lebanon, Morocco, and Tunisia. He argues that these AAEUs will provide a major impetus toward an open trade regime during the next 12 years and constitute a powerful catalyst for overall economic reform. However, benefits will be forthcoming only if major supplementary reforms are implemented consistently and front-loaded. An important challenge for the authorities would be to ensure continued macroeconomic stability while overseeing a socially acceptable transformation of the production structure of their economies. The chapter stresses that the success of the AAEUs will hinge on the countries' ability to generate a critical mass of foreign direct investment in labor-intensive, export-oriented sectors. This will require substantial further transformation, including liberal rules governing trade in services and property rights, privatization, reform of judicial and administrative practices, and a reduced role for the government. The chapter also provides preliminary estimates of static benefits for the countries under review and contends that firm macroeconomic policies with flexible exchange rates would need to be supported by well-focused EU assistance and cooperation. The addendum to Chapter 11, "Implementation of the European Union Association Agreements," by Hardy, Laframboise, and Martin, provides information on the progress of the AAEUs thus far in Jordan, Morocco, and Tunisia. Finally, in Chapter 12, "Estimating Trade Protection in Middle Eastern and North African Countries," Oliva studies the structure and evolution of trade protection in these countries during the 1990s. She argues that conflicts between pressures for liberalization to promote growth and imperatives to maintain unsustainable macroeconomic objectives (especially appreciated exchange rates) have determined the direction of trade policy. Whether the balance moved toward protectionism or liberalization depended upon the ability of the national authorities to deal with domestic imbalances and regional trading relations. It is particularly interesting that trade arrangements have so far been aimed mainly at promoting trade with industrial countries and not necessarily at encouraging intraregional trade. Oliva notes that Middle Eastern and North African countries use tariffs and nontariff barriers, and tariff dispersion and nontariff barriers, as substitute protection instruments, with tariff levels and tariff dispersion acting as complements. Excluding Tunisia, the cross-country correlation between tariff and nontariff barriers is 0.5, whereas the correlation between tariff dispersion and nontariff barriers is 0.8. The chapter also develops an overall index of trade protection and finds that tariff levels, their dispersion, and nontariff barriers account, respectively, for 30, 20, and 50 percent of overall protection. References Chabrier, Paul, 1998, "How Has the Asian Crisis Affected Other Regions?
1The
Middle East and North Africa region, in this context, encompasses the
Islamic State of Afghanistan, Algeria, Bahrain, Djibouti, the Arab Republic
of Egypt, the Islamic Republic of Iran, Iraq, Jordan, Kuwait, Lebanon,
the Socialist People's Libyan Arab Jamahiriya, Mauritania, Morocco,
Oman, Pakistan, Qatar, Saudi Arabia, Somalia, Sudan, the Syrian Arab
Republic, Tunisia, the United Arab Emirates, the Republic of Yemen,
and the West Bank and Gaza. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
