Export Group Meeting on the Contribution and Effective Use of External Resources for Development, in Particular for Productive Capacity Building 22-24 February 21 Debt Sustainability and the Implications of the Current Financial Crisis on the MENA Region By Professor Simon Neaime Department of Economics American University of Beirut The views expressed are those of the author and do not necessarily reflect the views of UNCTAD
Debt Sustainability and the Implications of the Current Financial Crisis on the MENA Region Simon Neaime Professor and Chair Department of Economics American University of Beirut Beirut, Lebanon Email: sn1@aub.edu.lb
Outline I. Debt and Exchange Rate Crises in Emerging Economies: An Overview II. Macroeconomic Implications of the Current Financial Crisis on the World Economy III. Macroeconomic Implications of the Current Financial Crisis on the MENA Emerging countries IV. Debt Sustainability and the Current Financial Crisis V. Ensuring Debt Sustainability: Current Remedies and Future Policy Implications All data/charts are gathered from the IMF s Regional Economic Outlook
I. Debt and Exchange Rate Crises in Emerging Market Countries: Mexican crisis of 1994: Devaluation of the peso to correct for a real exchange rate overvaluation Contraction in the economy Followed by debt crisis Asian crisis of 1997: Poor financial governance Pegged exchange rate regimes Fast capital account liberalization Weaknesses in the Asian financial systems Russian crisis of 1998: Steep devaluation of the Rubble by about 26 percent led to: 1. Significant growth of Russia s external debt and its service costs 2. Collapse of the Treasury bill market, coupled with a commercial banking crisis 3. Worsening of the budget deficit caused by reduction of the tax base, and the impossibility of further debt financing of the budget deficit
Brazilian crisis of 1999, and the Argentinean crisis of 21: Deficit financing through printing money led to hyperinflation Subsequently: Argentina defaulted on external debt Turkish crisis of 21: hyperinflation as a result of deficit financing But Turkey did not default on its external debt obligations Recent US Financial Crisis Credit derivatives and the mortgage market bubble The crisis has put pressure on emerging markets contributing to fast declines in their stock markets and GDP growth rates Leading in some cases to unsustainable public debt
II. Macroeconomic Implications of the Crisis on the World Economy: Downturns in Global Stock markets Equity Markets (1/1/27=1) 13 12 11 1 9 8 7 6 5 S&P 5 DJ Stoxx 6 Nikkei 225 FTSE 1 13 12 11 1 9 8 7 6 5 4 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 4
have negatively affected global economic growth: 12 1 8 6 4 2-2 -4-6 Real Growth Rates (In percent, quarter over quarter annualized) Real GDP Emerging World Industrial -8-8 1 2 3 5 6 7 8 12 1 8 6 4 2-2 -4-6
III. Macroeconomic Implications of the Crisis on the MENA Emerging Economies Oil Producing GCC Countries Non Oil Producing: MENA Countries
Implications for Emerging MENA countries: Key Transmission Channels Negative spill over effects from developed economies led to a decline in exports, FDI, remittances and tourism revenues Sudden stop in capital inflows, which could worsen public, corporate and banking sector vulnerabilities Byproduct an exchange rate and debt crisis
Oil Producing GCC Countries Oil sector was the most affected by the crisis. GDP growth rates fell significantly due to lower oil prices and exports. In the wake of the Dubai Financial Crisis, Financial sector vulnerabilities need addressing. Fiscal and Monetary Policies were however effective.
Financial crisis strikes the oil sector 8 6 Real GDP Growth (Annual change; percent) World Advanced economies MENAP oil exporters oil GDP 4 2-2 -4 25 26 27 28 29 proj. 21 proj.
GCCs Current account and fiscal balances have moved into deficits... Current Account and Fiscal Balances (In percent of GDP) 22 22 16 16 1 1 4 4-2 Current account balance Overall fiscal balance -8-8 2 22 24 26 28 21-2 Projections as of Jan. 29
12 1 8 6 4 2... and GDP growth is declining. Real GDP Growth, GCC Countries (Annual percent change) MENA Oil Exporters -2 Total GDP -2-4 Non-oil GDP -4-6 Oil GDP -6 2 22 24 26 28 21 12 1 8 6 4 2 Projections as of Jan. 29
In response, countercyclical fiscal policies were pursued, dampening the downturn in the non-oil oil sector Change in the Non-Oil Primary Fiscal Deficit, 29 (Percent of non-oil GDP) Real GDP Growth (Annual change; percent) 1 8 Fiscal impulse Automatic stabilizers Change in non-oil primary deficit 1 8 6 Real GDP Oil GDP Non-oil GDP 6 4 4 2 2-2 SAU UAE -4 25 26 27 28 29 proj. 21 proj.
As oil prices and exports fell and government spending rose, current account surpluses declined sharply Current Account Balance (Billions of U.S. Dollars) 3 25 GCC Other 2 15 1 5-5 27 28 29 proj.
Central Banks also responded promptly to stabilize the financial market 12 Central Banks Net Credit to the Banking System (Change as a percentage of base money) 1 8 6 4 2 BHR KWT SAU SDN
Non-Oil MENA Countries: Impact of the Crisis Impact of financial crisis has been limited, with growth declining to 3.8 percent in 29. Low integration with advanced stock markets has contained the effects of the crisis. Effective monetary and fiscal policy interventions have been instrumental. Limited fiscal space, exchange rate appreciation, and sluggish capital inflows imply recovery will be slow.
For non-oil oil MENA countries, slowdown because of weak growth prospects in trading partners Non-oil MENA US -2.6% 15% GCC 1/ 4.9% 12% EU-15-3.2% 1/ January 29 projection for non-oil GDP growth. 35%
Exports: a major transmission channel of the financial crisis Merchandise Exports, 29 (In percent of GDP) 45 4 35 3 25 2 15 1 5 GCC EU-15 USA Other Lebanon Pakistan Egypt Morocco Jordan Syria Tunisia 45 4 35 3 25 2 15 1 5
Lower Capital Inflows, and a drop in Exports MENA Non-Oil Countries: Capital Inflows (Billions of U.S. dollars) MENA Non-Oil Countries: Saving and Investment Balance (Percent of GDP) 12 1 28 29 proj. 21 proj. 27 25 Domestic savings (left axis) Gross national investment (left axis) Current account balance (right axis) -2 8 6 23-4 4 21-6 2 19-8 Export of goods Tourism receipts Remittances FDI 17 28 29 proj. 21 proj. -1
Accompanied by a Drop in Remittances Workers Remittances, 28 (In percent of GDP) 14 12 1 8 6 4 2 Syria Pakistan Tunisia Egypt Morocco Lebanon Jordan 14 12 1 8 6 4 2
Byproduct: Lower GDP growth rates Real GDP Growth (Annual percent change) 7 6 5 4 3 7 6 5 4 3 2 1 World MENA oil importers 2 22 24 26 28 21 Projections as of Jan. 29 2 1
Limited reliance on international capital flows... Emerging Market Bond Issuance (Billions of U.S. dollars) Cross-Border Loans (Billions of U.S. dollars) 8 6 Emerging markets (left axis) Lebanon (right axis) Other MENAP oil importers (right axis) 2 15 4 3 EGY PAK TUN Other 4 1 2 2 5 1 24:Q1 24:Q3 25:Q1 25:Q3 26:Q1 26:Q3 27:Q1 27:Q3 28:Q1 28:Q3 29:Q1 24:Q1 24:Q3 25:Q1 25:Q3 26:Q1 26:Q3 27:Q1 27:Q3 28:Q1 28:Q3 29:Q1
... contained the disruption of local credit markets Sovereign Bond Spreads (Basis points) MENA Non-Oil Countries: Private Credit Growth (Annual percentage change) 25 2 15 1 5 1/1/28 2/17/28 4/4/28 5/21/28 7/7/28 8/23/28 1/9/28 11/25/28 1/11/29 2/27/29 4/15/29 6/1/29 7/18/29 EGY LBN MAR PAK TUN EMBIG 9/3/29 25 2 15 1 5 Jan-8 Mar-8 May-8 Jul-8 Sep-8 Nov-8 Jan-9 Mar-9 May-9
Fiscal policy intervention constrained by limited fiscal space Real T-Bill T Rates and Total Public Debt/GDP, 29 (Percent) Change in Non-oil oil Primary Fiscal Deficit, 21 (Percent of non-oil oil GDP) 16 1 Lebanon Total Public Debt/GDP 12 8 4 Egypt Pakistan Tunisia Morocco Jordan Less fiscal space Mauritania -5 5 1 Real T-Bill Rates -1-2 -3 Automatic stabilizer Fiscal impulse Change in primary deficit JOR LBN MAR SYR TUN
CPI is on the decline, but real effective exchange rates have appreciated MENA Oil Importers: Consumer Price Inflation (Annual percentage change) Effective Exchange Rates (Percent change, year to July 29) 21 19 17 15 13 11 9 7 Jan-8 Feb-8 Mar-8 Apr-8 May-8 Jun-8 Jul-8 Aug-8 Sep-8 Oct-8 Nov-8 Dec-8 Jan-9 Feb-9 Mar-9 Apr-9 May-9 Jun-9 15 1 5-5 -1 Nominal Real DJI EGY JOR LBN MRT MAR PAK SYR TUN
With limited fiscal space, and exports on the decline, growth will depend on private consumption Non-oil oil MENA countries: Contribution to Real GDP Growth (Percent) 1 8 6 Net exports Investment Consumption Real GDP Growth 4 2-2 -4 28 29 proj. 21 proj.
Capital Adequacy Ratios have remained robust Capital Adequacy Ratio (Percent) 35 3 27 Latest 25 2 15 1 5 DJI EGY JOR LBN MRT MAR PAK TUN
IF... Potential Risks Private consumption fails to pick up With limited fiscal space A prolonged recession Then Further strains on bank/corporate balance sheets Unsustainable public/private debt
IV. Implications of the Crisis on MENA Debt Sustainability Foreign Debt Domestic Debt Considered as a more serious threat to an economy because: It involves a transfer of capital to foreign creditors Debt service payments are limited by foreign exchange export earnings Rests mainly on domestic borrowing May be financed sometime through either domestic taxes or through seigniorage revenues
Figure 1. Composition of non-oil MENA countries Debt to GDP in 29 (%)
Effects of the Current Crisis on Debt Sustainability 1. Lower GDP Growth Rates Lower government revenues Budget deficits & difficulties in servicing domestic debt 2. Lower levels of capital inflows/fdi Difficulties in rolling over current outstanding debt 3. Lower level of exports Current account deficits & difficulties in servicing foreign debt
For Oil Exporting Countries further declines in oil prices Further budget deficits Slower GDP growth rates Further accumulation of public debt Recent record oil price decreases and revenues negatively affected growth outlook in all MENA countries Lower oil revenues since 28 low liquidity in GCC countries (& negative spill over effects in non oil MENA countries) Higher interest rates negative impact on budget deficits & on the service of the accumulated domestic public and private debt
Low income economies with fixed exchange rate regimes & with foreign debt were hard hit by the crisis due to: 1. Losses of reserves in trying to maintain their pegged exchange rate regime 2. Inability to use effectively monetary policy to absorb the effects of shocks emanating from the crisis 3. Risk of an exchange rate crisis & default on foreign debt 4. Experience a BOP crisis due to: terms of trade shocks Those countries need immediate foreign assistance decline in export demand reduction in tourism & remittances flows 5. Potential bank failures (depending on their exposure to public debt) 6. Difficulties in tapping international financial markets
Low income emerging economies with flexible exchange rates regimes & domestic debt were less affected due to: 1. More room to maneuver domestically due to the effective use of monetary policy to absorb the effects of shocks emanating from the crisis. 2. 1 st line of defense against debt default: Foreign reserves 2 nd line of defense: Increases in interest rates
The current financial crisis has accentuated: Current account and budget deficits of several emerging economies Coupled with a fixed exchange rate system These countries will have to generate foreign currency from sources other than exports in order to: (1) Cover a widening huge gap between exports and imports (2) Service a fast growing external debt (3) Maintain their pegged exchange rate regime If such hard currency is not generated, the by-product would be the continuous accumulation of unsustainable external debt & subsequently a currency crisis
If these countries still opt for maintaining fixed exchange rates they will have to implement crisis-prevention measures by: -Exercising fiscal discipline -Managing properly their debts and foreign reserves -Avoiding future real exchange rate appreciations Under a fixed exchange rate regime monetary policy is geared solely towards maintaining the pegged regime If central banks fail in maintaining their peg devaluation debt crisis In this case domestic macroeconomic policies alone will no be sufficient and an international intervention is warranted
V. Ensuring Debt Sustainability in Emerging Economies in the Wake of the Crisis The structure of emerging countries public debt highlights the vulnerability of their debt burden to abrupt interest and exchange rate movements & hence is crucial when assessing future debt sustainability Some emerging countries will need to alter their debt structure by converting the short maturity portion of the debt with high debt service cost into a longer maturity debt with lower debt service cost. Other Emerging countries will need to convert portions of their foreign into domestic debt to reduce their exposure to exchange rate volatility and avoid difficulties in tapping international financial markets.
For Countries with a debt structure that is mostly domestic, transition to a flexible exchange rate regime may dampen the negative effects of the crisis : In the short run, those countries will have to keep fiscal policy tight to reduce their debt & to ensure its sustainability Those countries would need to begin by introducing proper fiscal adjustment measures & debt management policies to reduce the level of their debt They will have to continue strengthening the financial & banking sectors to address the fiscal imbalances & further mitigate any potential for a future debt or currency crisis
One relevant case is Egypt: -Effectively absorbed the effects of shocks emanating from the current crisis -Although its stock market incurred losses due to its integration with the more mature markets. Through a series of controlled devaluation since 24, Egypt was able to : Stimulate exports and subsequently GDP growth Generate enough foreign currency to reduce the levels of its foreign debt The recent float of Egypt s currency rendered monetary policy more effective: Easing up the pressure on domestic interest rates Contributing in lowering debt service and public debt Contributing in the containment of the recurrent budget and current account deficits
Enhancement of local capital markets especially stock markets may also dampen the effects of the crisis & may reduce exposure of private corporations to currency mismatches due to foreign borrowings -Those corporations will be able to raise funds locally & reduce their exposure to external financial shocks -They will also reduce any currency mismatch (Exchange rate risk) in their balance sheets -They will also dampen the implications of any sudden outflows of capital emanating from the current crisis
Sudden capital outflows may lead to (As was the case during the East Asian Financial crisis): A series of corporate failures putting more pressure on public finances (in case of forced bailouts) rendering external public debt unsustainable More demand by private corporations for foreign exchange which could put further pressure on foreign reserves (If the exchange rate is fixed) and may lead to a currency and debt crisis
Policy Priorities Proper Management of financial/corporate balance sheet effects of asset price falls to sustain private debt Enhance existing capital markets Introduce some flexibility in the exchange rate
Policy Recommendation Oil Producing GCC Countries: - Continue to exploit government spending - Enhance local financial markets. Non-Oil MENA Countries: - Exploit fiscal space if still available Effective use of monetary policy, if possible Enhance financial supervision and monitoring - Introduce fiscal reforms and enhance debt management policies (debt structure)
Summary GCC countries have been directly hit by the financial crisis through a sharp decline in oil prices and revenues But the impact has been mitigated to a great extent by countercyclical monetary and fiscal policies coupled with substantial reserves built up prior to the crisis Financial market development including the enhancement of the local bond and stock markets should remain a priority. In 21, All MENA countries are likely to suffer the impact of slower growth (which will hamper "growing out of debt"), lower receipts from oil-producing countries, and further increases in government debt due to spending in the context of fiscal stimuli packages.
Summary MENA non-oil countries have been moderately hit by the crisis. A low degree of integration with international capital markets was instrumental in preventing a sever financial crisis Limited exposure of the banking system to derivative products, and positive spillovers from increased public spending in GCC countries have helped these countries so far in avoiding a debt and exchange rate crisis The negative spill over effects from advanced economies has been through a reduction in capital flows (exports, FDI, remittances and tourism revenues).