Office of the Chief Economist Middle East and North Africa Region MENA MONITOR April, 13 Number 3 MENA: Economic Pressures Mount In 13, regional growth is expected to slow to 3.8 percent from.1 percent in 1. Regional growth in 1 was stronger than expected, mostly due to better than expected performance in a number of oil exporters, and in particular an especially sharp rebound in oil production in Libya. The growth deceleration into 13 largely reflects a return to more sustainable growth in oil exporting countries. Egypt s growth is expected to weaken relative to 1, but in other oil importing countries economic activity is expected to expand faster than in 1. Growing macro imbalances in oil importers pose serious risks. With the exception of Libya, fiscal deficits have worsened significantly in all the transition economies since 1, as distortions due to rising expenditures on fuel subsidies and a large public sector have expanded. Current account positions are also deteriorating, government debt is up 1 percentage points, and international reserves are under pressure. The already difficult employment situation has worsened in the post revolutionary economies. In Egypt and Tunisia, unemployment is up about percentage points from before the Arab Spring. The main challenge now is generating the economic and political confidence that will renew spending by investors, tourists, and consumers. Transition has disproportionately affected the employment creating sectors. In Egypt, for example, manufacturing, construction, and tourism related services have been most affected. Public works in infrastructure offer one way to support job creation relatively quickly, while greater political and economic stability would have a more broad based impact and boost activity in the manufacturing and tourism related sectors. This outlook is subject to a variety of risks. Political instability, policy uncertainty, and weakened macroeconomic fundamentals are the key challenges facing developing MENA countries, with slow growth in Europe posing additional problems, especially for Morocco and Tunisia. Political Context The process of political change continued into 13, with a great degree of heterogeneity across countries in the Middle East and North Africa. Violence in Syria has escalated, with spillover effects to the countries in the Mashreq area, especially Lebanon and Jordan. In Lebanon, violent incidents near the border with Syria have increased sectarian tensions and worsened the political divide in the country, with negative consequences for political stability and economic growth. In Jordan, the influx of refugees from Syria has put a strain on resources, and also presents a threat to the country s own stability. The drafting of new constitutions remains a key pending issue in the post revolutionary economies of the Middle East and North Africa. Security in Yemen is fragile, but progress has been made in reforming the security institutions and preparing for a six month national dialogue. The process will bring stakeholders to draw up a new constitution and April 13. Number 3 1
prepare the ground for presidential and parliamentary elections. In Tunisia, deepening political tensions and continued social instability have delayed the preparation of the new constitution and the next national elections. The schedule to form the new Libyan constitution has slipped, yet the interim government is working to improve security and the capacity of public institutions. The political environment in Egypt remains highly fragmented, following the referendum on the new Constitution in December 1. The Constitution was approved by a small majority but with low voter turnout. Challenges to the election law will likely delay the new Parliamentary elections to the second half of the year. Meanwhile, episodes of social unrest continue to occur across the country. Macroeconomic performance Expectations vs. reality in 1 The regional economy is estimated to have expanded by.1 percent in 1, due to the strong performance of oil based economies (column, Table 1). The GCC economies registered growth estimated at 5. percent, with Saudi Arabia growing at a rate of close to 7 percent. Regional growth in 1 is now estimated to be stronger than was projected last Fall (column 1, Table 1), largely due to better than expected growth in several oil exporters, with an especially sharp rebound in oil production in Libya. Despite a difficult global environment, oil exporters benefited from high oil prices and production, while improved oil revenues supported domestic spending and investment. As expected, there was weakness in the oil importing countries, where real economic activity expanded at just.5 percent in 1 (for details, see Appendix). In Egypt, growth in FY1 averaged. percent, constrained by political uncertainty and social unrest which hurt investment and net exports. Growth in Lebanon was much weaker than projected earlier and averaged just 1. percent in 1 the lowest growth rate since because the security situation deteriorated and hurt private consumption and tourism. There was also weakness in Jordan and Morocco where growth fell below the 3 percent originally expected and averaged.8 percent and.7 percent, respectively. Sluggish external demand and high prices of imported commodities constrained their economic performance, with Morocco hurt also by low agricultural production and the weak European economy. Tunisia, however, surprised with a stronger than expected growth outcome, largely due to a greater than expected rebound in tourism and mining, and the impact of increased consumption through wage increases and social programs. Table 1. Growth expectations for 1 1p in 1e Fall '1 Spring '13 MENA 5.5.1 Oil exporters.5 7. GCC oil exporters 5.1 5. Post revolutionary oil exporters 57.9 71. Other developing oil exporters.5.8 Oil importers..5 Source: World Bank. Note: Numbers in the table are projections for 1 as of September 1, denoted as 1p Fall 1, and March 13, denoted as 1e Spring 13. Changes since the Arab Spring Macroeconomic fundamentals have deteriorated in the developing MENA countries since the onset of the Arab Spring. Despite recoveries in 1, growth remained below the average growth observed in the period 1, except in Libya where the extraordinary rebound in 1 offset a similarly sharp drop in the previous year (Figure 1). Political instability, sectarian divisions, and unrest took their toll on economic activity and investment. Weakness in the global economy, and the EU, in particular, made the situation worse for Tunisia and Morocco, which have close ties with the EU. Jordan and Lebanon also experienced spillovers April 13. Number 3
from conflict in Syria, negatively impacting growth. 7 5 3 1 Figure 1. Growth before, during, after the Arab Spring (annual % change) 1.5 Source: World Bank. Libya Yemen Egypt Tunisia.1 1.5 1 11 1 Morocco Jordan Lebanon 1 11 1 Unrest in the region has hurt the tourism sector in many countries. In Egypt, for instance, the tourism related sectors, including the hospitality industry, air transport, and retail trade, were particularly hard hit (Figure ), and so were the manufacturing and construction industries. In 1, these sectors jointly contributed over percent of total valueadded and employed around 3 percent of all active participants in the labor force (Figure ). Agriculture the largest employer and third largest sector also played a part in the growth slowdown. Indeed, all sectors other than the Suez Canal, contributed negatively to output growth between 1 and 1. Overall, the employment situation has worsened in Egypt and Tunisia since the onset of the Arab Spring. Job creation slowed and unemployment rose in sync with the output growth slowdown. According to official sources, in the last quarter of 1, the unemployment rate in Egypt was 13 percent, up more than percentage points from the pre revolutionary rate in 1. Tunisia presents a similar picture, with unemployment jumping by slightly less than percentage points between 1 and 1. These developments have worsened the situation of the poor and vulnerable. According the most recent data, the poverty rate in Egypt rose from percent in 8/9 to 5. percent in 1/11, and has likely increased further since then. Public works in infrastructure offer one way to support job creation relatively quickly. According to a World Bank study on infrastructure and employment creation in the MENA region (Estache et al. 1), the region could generate.5 million jobs by meeting annual infrastructure needs. However, these jobs would be lost if countries reduce their public investment rates going forward, as has happened recently when many countries with fiscal constraints trimmed the investment portion of their budgets but expanded recurrent expenditures to fund increases in subsidies, pensions, and public wages. Fiscal vulnerabilities increased throughout the region, reflecting the impact of growth decelerations on government revenues, and increases in public spending in response to the political upheavals (Figure 3, top left chart). Government deficits widened substantially: in the case of Yemen by as much as percent of GDP, while increases in other postrevolutionary economies were smaller, but sizable (Figure 3, top right chart). The quality of government spending also deteriorated because in most countries the increase in spending was driven by expansion in recurrent expenditures on wages, pensions, subsidies, and other social programs, and not by growth enhancing, public investment spending. In Morocco, for the first time, the government spent more on subsidies (. percent of GDP) than on public investment (5.8 percent of GDP). April 13. Number 3 3
Figure. Industry contributions to value added growth and employment by sector in Egypt Changes in contribution to GDP growth, 1 relative to 1 Percentage points Manufacturing Construction Wholesale & Retail Trade Restaurants & Hotels Communications Transportation & Storage Social Solidarity Brokerage & Subsidiary Activities General Government Mining Education & Health Agriculture, Irrigation & Fishery Real Estate Activities Insurance & Social Insurance Water Information Electricity & Sanitation Suez Canal.7.51.3..3.18.1.1.11.11.9.7.3.1.1.1...8...... Sectoral share of employment, 1 Percent Agriculture, Irrigation & Fishery Manufacturing Wholesale and retail trade Construction Education & Health Public administration Transportation and storage Other service activities Restaurants & Hotels Electricity Professional activities Information and communication Financial and insurance activities Water Administrative service Services of HH as employers & Arts, entertainment and recreation Mining Real Estate Activities 3.. 1.1 1..9.8...5.3... 7.8 1.1 11.3 11.3 11. 8. 5 1 15 5 3 Sectoral shares in GDP, 1 Percent Manufacturing Mining Agriculture, Irrigation & Fishery Wholesale & Retail Trade General Government Construction Transportation & Storage Restaurants & Hotels Communications Education & Health Brokerage & Subsidiary Activities Social Solidarity Suez Canal Real Estate Activities Electricity Water & Sanitation Insurance & Social Insurance Information..3. 1. 3..8 5.3.3.3.1.1 3.9 3.5 8.8 1.7 13. 13.7 Shares in GDP 1.1 8 1 1 1 1 18 Source: Egypt: Central Bank and Central Agency for Public Mobilization & Statistics (CAPMAS). April 13. Number 3
Figure 3. The macroeconomic situation since the onset of the Arab Spring 5 3 1 Increase in government spending ( % of GDP) 1 compared to 1 Egypt Morocco Tunisia Jordan Yemen Subsidies Wages and salaries 8 8 1 1 Change in twin deficits, % of GDP 1 relative to 1 Egypt, Arab Rep. Tunisia Jordan Morocco Lebanon Yemen Fiscal deficit Current account deficit 1 1 1 8 Increase in government debt to GDP 1 1 Yemen Tunisia Egypt Morocco Jordan Increase in government debt to GDP, percent 35 3 5 15 1 5 Egypt, Arab Rep. 1M1 International Reserves, US$ bn Jordan Morocco Tunisia Yemen, Rep. 1M1. Data for Egypt and Jordan are for 13M 1 1 8 Change in key prices 1 relative to 1 8 7 5 3 1 Sovereign Bond Interest Rate Spreads, Basis Points over US Treasuries Egypt Jordan Morocco Tunisia Lebanon Yemen Annual Inflation (ppt) Exchange rate (LCU/US$, %) Egypt, Arab Rep. Lebanon Tunisia Source: World Bank, IMF and Datastream. Note: Annual Data for Egypt corresponds to fiscal year. April 13. Number 3 5
Consequently, government debt grew as a share of GDP in most developing countries of the Middle East and North Africa (Figure 3, middle, left chart). In Egypt, the government has relied increasingly on short term domestic debt instruments and its interest payment obligations increased by 33 percent in the second half of 1 compared to the same period in the previous fiscal year. Egypt s access to external markets has diminished significantly as credit agencies lowered its credit ratings. In late December 1, Standard & Poor s cut Egypt s long term credit rating to the same level as Greece. Consequently, Egypt s sovereign interest bond spreads skyrocketed to nearly 7 basis points over US Treasuries (Figure 3, bottom, right chart). Jordan s debt grew at the fastest pace among developing countries in the region during the period 1 1, adding 1 percentage points to its debt to GDP ratio (Figure, 3, middle, left chart). In Egypt and Morocco, government debt increased sharply as well, rising by nearly 7 percentage points in the two years since 1. External positions have worsened across developing MENA since 11 (Figure 3, top right chart) as net exports and investment flows declined. Foreign direct investment inflows (FDI) declined between 1 and 11 (Figure ). The drop was particularly dramatic in Egypt, though estimates suggest that in 1 FDI in Egypt may have recovered some ground. Lebanon s external position saw an improvement due to increased capital inflows driven by widening domestic international spreads. Yemen s current account deficit narrowed as well due to a US$ billion Saudi grant. Consequently, gross reserves increased to US$ 5. billion, equivalent to slightly less than months of imports, and up from months in 11. This financial support built confidence and strengthened the currency, narrowing down the wide gap between official and black market rates (Figure 3, bottom, left chart). Currencies have weakened, however, across oil importing North Africa despite the governments move to protect them by drawing down on foreign exchange reserves. Foreign reserves dropped substantially, most notably in Egypt, and less so, in other oil importing countries (Figure 3, middle, right chart). The drop in Egypt occurred despite balance of payment support from Qatar (US$.5 billion) and Turkey (US$.5 billion). At less than 3 months of imports and almost half of them in an illiquid form, reserves in Egypt are inadequately low. The Egyptian pound has depreciated by 1 percent relative to the US$ since late December 1 when the central bank introduced foreign exchange auctions and a black market emerged in response to rationing and new regulations, where the pound is reportedly trading at more than LE7/US$. Other signs of economic stress have also emerged, including shortage of fuels and certain types of foods and products, rising premiums between official and black market prices, and increased dollarization. Recently announced lending from Qatar (US$3 billion) and Libya (US$ billion) could provide temporary relief. Figure. Foreign Direct Investment Flows (US$ bn) 8 7 5 3 1 1 Source: UNCTAD. Egypt Libya Tunisia Yemen Jordan Lebanon Morocco Economic outlook 9 1 11 In 13, regional growth is expected to slow to 3.8 percent from.1 percent in 1 when the region started recovering from the political turmoil in 11. The growth deceleration into 13 largely reflects a return to more sustainable growth in oil exporting countries. They grew at a very high pace in 1 because of strong oil prices and production, and a April 13. Number 3
dramatic rebound in Libya, following the production collapse of 11. Recovery is expected to strengthen in Yemen, assuming that the national dialogue produces a credible political solution and a stable government emerges, capable of forging ahead with reforms and project implementation. Uncertainty shrouds the outlook in many developing MENA countries, but risks are especially elevated in Egypt, where the economic situation has continued to deteriorate. The economy contracted by. percent q/q in the last quarter of 1, dragged by agriculture which contracted by percent q/q. The weak external environment brought down Suez Canal proceeds by 5. percent q/q, but these are expected to have recovered in the first quarter of 13. Transport and electricity also posted a double digit contraction. Offsetting these declines to some extent, the recovery in construction remained uninterrupted and tourism expanded by 15 percent q/q. Still, PMI data shows that private activity continued to contract in March, and there are no signs that the downturn is slowing. Thus, Egypt s economic outlook for FY13 is subject to many risks and will depend on whether a more inclusive and politically stable structure is achieved and how quickly a credible stabilization and reform program supported by the IMF and other donors can be introduced. Economic growth in Egypt is expected to weaken relative to FY1 (fall below just percent for the year). In the absence of a large external support package, short term pressures on the exchange rate and inflation are likely to intensify in the months ahead, shortages of currency and product hoarding will grow and erode confidence which will further depress the weak private sector demand. Finally, unless the delay in fiscal adjustment is avoided and fiscal consolidation takes place, Egypt s financing needs will grow and the fiscal deficit could exceed 1 percent of GDP. With limited external financing, the growing budget deficit will be financed primarily by domestic banks, which will put upward pressure on short term interest rates and likely crowd out the private sector. With the slowdown in FY13, Egypt will complete its third year of near zero growth in per capita terms. No doubt, lack of progress will disappoint millions of Egyptians, especially the poor, who expressed their frustration with the economy before the Arab Spring when growth was robust. Verme (13) shows that on average household welfare in Egypt did not improve in real terms between and 8, despite high reported growth in the economy. During the same period, there was a sharp rise in inequality aversion (measured by the proportion of people who think that incomes should be more equal) across almost all income groups and a decline in self reported income and status. With shortages of inputs such as fuels, black market prices of these goods are many times higher than those people expected to pay a few months ago. These shortages could deter farmers, with negative consequences for food security, price stability, and poverty. Growth in all other oil importers is expected to accelerate relative to 1 (see Appendix Table), provided the political transitions proceed smoothly and governments make progress with fiscal consolidation and other needed reforms. Developments in Europe will also impact the outlook in Morocco and Tunisia. Twin deficits will have to be addressed decisively in order to avert further macroeconomic deterioration, improve confidence and stimulate the private sector. Meanwhile, post revolutionary oil importing MENA countries remain dependent on external financing from official sources. Take away messages In 13, regional growth will slow to 3.8 percent from.1 percent in 1, when the region started recovering from the political turmoil in 11. The growth deceleration into 13 largely reflects a return to more sustainable growth in oil exporting countries. Egypt s growth will weaken relative to 1, but April 13. Number 3 7
in other oil importing countries economic activity will expand faster than in 1. This outlook is subject to a variety of risks. In the short run, political instability, policy uncertainty, and weakened macroeconomic fundamentals are the key challenges in developing MENA, although developments in Europe could pose additional problems, especially for Morocco and Tunisia. Fiscal vulnerabilities have increased, reflecting sustained, high public spending in response to political upheavals. External deficits have widened due to declines in foreign investment flows and export receipts. Inflation has picked up, and currencies have weakened, despite moves by governments to avoid currency depreciations by drawing down on foreign exchange reserves. Reforms are urgently needed to ease the macroeconomic pressures, restore confidence, and encourage the private sector. However, an effective reform agenda is less likely to succeed in a climate of political instability and infighting. MENA countries continue to face the structural problems that predate the Arab spring. The region s main challenge is to create sustainable growth that delivers the quantity and quality of jobs needed. However, since the onset of the Arab Spring, the employment situation has worsened in some of the post revolutionary economies. In Egypt, for example, the transition process has taken a heavy toll on sectors employing sizable shares of Egypt s active labor force. Public works in infrastructure offer one way to revive job creation relatively quickly, while a greater stability will have a more broadbased impact and serve as a boost to activity in the manufacturing and tourism related sectors. This issue was prepared by Elena Ianchovichina (Lead Economist) with assistance from Lili Mottaghi (Economist) and under the guidance of Caroline Freund, Chief Economist, Middle East and North Africa Region of the World Bank. We thank Manuela Ferro, Bernard Funck, and country economists for their valuable inputs. References Verme, P. (13) Inside Inequality in Egypt: Facts and Perceptions in the Light of a Social Revolution, mimeo. Eastache, A., Ianchovichina, E., Bacon, R. and Salamon, I. Infrastructure and Employment Creation in the Middle East and North Africa, Direction in Development Series, World Bank. April 13. Number 3 8
Appendix Table. Macroeconomic outlook by country and country groupings Real GDP Growth Fiscal balance Current account balance 1 11 1e 13p 1 11 1e 13p 1 11 1e 13p (Annual percentage change) (in percentage of GDP) (in percentage of GDP) MENA.7 3.7.1 3.8.5 1.8 3.9 3. 7.7 1. 1. 9. Excluding Post Revolutionary Economies. 5.5 3.5 3.5 1.3 3.8 5.. 8.9 1. 11. 1. Developing MENA 5..1.7 3.1 3.1.7..1. 1...5 Developing Post Revolutionary Economies 5.. 1.7 5.3 3.3 9.5 3.1 3.9 1.9..3 3. Other Developing MENA 5..5.3 1.7 3..8...1 3. 1..8 Oil Exporters..1 7...3.3 7. 5.5 1.9 1.5 1.3 1. Excluding Post Revolutionary Economie. 5.7 3. 3..1 5.. 5. 1.8 1.9 13. 1.3 GCC. 7.7 5..5.8 9.3 1.7 1.1 1...8 18. Bahrain 3.1.1 1.8..9 5..8 3..1 3... Kuwait. 8.3. 1.1.3 3. 31. 5.1 3.8 1.. 39.5 Oman 5. 5. 8. 7. 5. 9. 9. 7.5 8. 1.7 1.8. Qatar 1.7 13.. 5.. 8. 8.1 1..8 3. 9.8 9.8 Saudi Arabia.1 8.5.8. 5. 8.3 13. 8.7 1.9 19.9 19.9 1. United Arab Emirates.9.9.3.8.1.9 7.7 7. 3.1 9. 1.3 1. Developing Oil Exporters 5.3. 1.9 3. 1.1.5 1. 1.3.. 5.. Post Revolutionary Economies 5.8 37.1 71. 15.7.7 1.3 13. 11.8 1..7.8 18.8 Libya 5..1 1.5. 8.9 18.7. 19.1 19.5 9.1 35.8.7 Yemen, Rep 7.7 1.5.1. 5. 5. 11. 7.5 3.7. 1..3 Rest of Developing Oil Exporters 5. 1.7.8.7.1 1.5 3.7 3. 5.1.5 1.5 1.7 Algeria 3...5 3. 1.8 1.3 3. 1.3 7.5 9.9 8.1 7. Iran, Islamic Rep. 5.9 1.7 3. 1.3 1.8. 5. 5.8 5.9 5. 1.8 1. Iraq 5.9 8. 8. 9..3.9.1 1. 3. 1.5 7. 3.8 Syrian Arab Republic 5.1 3. 1.3 3.5 5.1. Oil Importers.7.5.5.8. 8.5 8.7 9.5 5.3.3 7.5.3 Post Revolutionary Economies.8 1.... 8.8 9.8 1.7.5 3. 3.9 3. Egypt, Arab Rep 5.1 1.8. 1.9 7.8 9.9 1.7 11.5.. 3.1. Tunisia 3.1 1.9 3. 3.8 1.1 3.5 5.1 5.9.7 7.3 8.1 7.9 Rest of Oil Importers..5. 3.8.5 8. 7. 7.5 9.7 1.8 13.5 11. Djibouti 3.5.5.8 5..5.7 1..9 5.8 1. 1.1 11.9 Jordan.3..8 3.3 7.7 1.7 1. 9. 7.1 1. 18.1 1. Lebanon 7. 3. 1..3 7.7 5.7 9. 9.. 1.1 1. 15.7 Morocco 3. 5..7.5.7.9 7. 5..5 7.9 9. 8. West Bank & Gaza 9.3 1. 5.9 5. 17. 1.9 1.5 1.9 5.9 33.7 33.3 9.7 Source: World Bank. Fiscal year data are reported for Egypt. April 13. Number 3 9