External Environment
The external environment affects individual MENA countries through the goods market, the labor market, and to a lesser extent, capital flows. The importance of each of these three transmission channels depends on the circumstances of individual countries. Looking forward, several countries face, at best, a neutral outlook with substantial downside risks associated with oil-market developments. Consequently, these countries cannot look to their external environment either as a source of substantial windfall gains or as a significant stimulus for growth. This, as well as the legacy of the underexploited opportunities of recent years, strengthens the case for the economic reform policies. Fortunately, the possibility of more favorable regional sociopolitical conditions following the eventual attainment of a comprehensive, just, and durable peace provides support for the effectiveness of such policies, as do the prospects for increased economic interactions with the EU.
Projections prepared by the IMF staff during the 1995 World Economic Outlook exercise suggest a favorable outlook for the region's non-oil exports, as real demand in partner countries (weighted by their share in the region's exports) is expected to grow at an average annual rate of just over 5 percent in 1996-2000. Accordingly, the non-oil sector can provide an engine of growth for several countries and its development should be encouraged. The scope for expansion is significant: non-oil exports account currently for only a quarter of the region's exports, with Israel accounting for almost half this total.
As regards petroleum prices, there seems to be a consensus that, at best, nominal prices will increase moderately and real prices will remain constant or will decline. The consensus reflects expectations of restrained growth in world demand as further reduction in energy intensity offsets new demand, particularly by developing countries. At the same time, non-OPEC suppliers are expected to maintain broadly their current market shares, albeit with some uncertainty about developments in the republics of the former Soviet Union. The potential timing and conditions of Iraq's return to the oil market are also uncertain. Such a return would impose downward pressure on international prices and require some reallocation of shares among existing producers in order to limit the price decline.
Turning to the region's imports, the 1995 World Economic Outlook projections suggest moderate increases in import unit values (in U.S. dollar terms). Thus, after the nearly 8 percent increase estimated for 1995, prices of non-oil imports are expected to rise by an annual average of 1 1/2 percent during 1996-2000. A source of upward pressure in this context is the price of food imports, an important component of the region's total import bill. The moderate increase projected in import unit values incorporates a limited rise in food prices as the overall supply, particularly from producers in nonindustrial countries, responds to reductions in subsidies induced by the Uruguay Round in industrial countries. Slower output responses in nonindustrial countries would place upward pressure on international food prices, worsening MENA's external terms of trade.
The Uruguay Round is expected to have other effects on the goods market for the MENA region through the recent agreements on multilateral trade liberalization:
At the same time as employment opportunities in Europe are projected to decline, the potential for intra-regional migration--from the non-oil to the oil-exporting countries (mainly the GCC countries)--is expected to decline as well. With the current outlook for the oil market, the oil-exporting countries of the MENA region need to adopt strong fiscal adjustment and reform measures. In the short term, these measures will inevitably involve expenditure reduction with dampening effects on activities in which MENA nationals from the non-oil exporting countries are typically employed. Furthermore, structural reforms to reduce the size of government (typically the largest employer of nationals) need to be accompanied by improved employment opportunities for nationals, including types of work traditionally available to immigrant workers. Indeed, in the face of economic contraction, several countries have already adopted policies to encourage greater participation of nationals in the labor force.
Finally, the market for Palestinian labor in Israel will continue to depend on security issues influencing Israel's border policy. In addition, the increasing influx of Asian labor is likely to reduce the demand for Palestinian labor in the Israeli economy.
The development of local capital markets and their integration into the international capital market are less advanced in MENA countries than in Latin American and Asian economies. Typically, equity markets in the region are undercapitalized and in a number of cases are closed to foreign investors. As a result, Arab countries account for only a negligible flow of funds into equity markets in developing countries.
In recognition of the need to attract sustainable inflows of private capital and given the potential for capital markets to finance productive investments, many MENA countries are emphasizing financial sector reform (bank and capital markets) to encourage the mobilization of funds from domestic, regional, and international sources, and to minimize the associated risks. However, these efforts coincide with a reassessment of market perceptions regarding flows from industrial to developing countries. The reassessment reflects two developments. First, after declining sharply in 1991-93, short-term nominal yields rose in 1994 in several industrial countries (the United States in particular). This rise has, ceteris paribus, reduced the attractiveness of developing country instruments. Second, the Mexican crisis of December 1994, by heightening perceptions of developing country risk, has slowed international diversification by investors in industrial countries. As a result, developing countries need to compete for private flows from more cautious investors--this at a time of growing pressure on aid budgets in most industrial countries.
The establishment of a comprehensive, just, and durable peace in the Middle East is expected to result in a significant economic peace dividend, provided it is accompanied by sound economic policies. How much the peace dividend is worth is difficult to estimate, but military spending cuts could over time lead to higher capital formation and less severe resource misallocation. The impact is expected to be large but will probably materialize with some lag.
This impact will be compounded by efficient welfare-enhancing regional projects, particularly in infrastructure. Water management is most frequently identified as a source of potential gain from regional integration, and discussions among the various parties on how to develop and manage the limited and rapidly depleting water resources have already begun. Similar growth and development opportunities would clearly be enhanced for all MENA countries by a regional approach to sharing energy resources and developing an efficient energy distribution system. A coordinated approach to the development of a regional transport network would also be advantageous for all parties. Tourism has growth potential in many countries of the region, and larger tourist inflows would benefit from both a more integrated transport system and a regional approach to the promotion of this sector.
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