Mena moves beyond muddling through

Two-and-a-half years after the onset of the Arab Spring, the Middle East and north Africa (Mena) region continues to face a slow transition to democracy, with the political situation in Egypt, Libya, Iraq and Tunisia remaining precarious, reinforcing economic vulnerabilities, while the ongoing war in Syria is exacerbating weaknesses in its neighbours, Jordan and Lebanon.

While transition is always difficult, the slow progress and interlinked political and economic vulnerabilities cast a pall over the near-term outlook of the region’s oil importers, amplifying problems already caused by weakened eurozone demand and other stresses. Support from the International Monetary Fund (IMF), the Gulf Co-operation Council (GCC) and Mena citizens abroad have helped countries such as Egypt and Tunisia muddle through, but the deterioration in the political and security infrastructure, and the weakening of institutions, suggest growth and investment lag behind.

Call for reform

While the effect of transition creates some long-term positives, the region has to move beyond this muddling through of short-termist stabilisation policies to increase potential growth. While the wealthier regional governments can pump money into supporting key industries, the next step requires a series of short- and long-term reforms to begin positive feedback loops through government support to the private sector.

The Arab Spring has reinforced the macroeconomic performance of regional oil exporters as these countries have the resources to transfer more wealth to their populations.

In 2013 and 2014, the GCC is likely to continue to outperform its Mena counterparts in terms of economic growth and asset performance, particularly if supply shocks in Libya, Iraq and Iran keep oil prices and GCC production elevated. Ample revenues have facilitated short-term policies and reduced pressure to improve the business environment, which suggests that this unstable muddle-through could continue for some time. Doing so would put off the long-term positives of the region.

The good news is that while countries such as Egypt have numerous challenges today, including weaker internal capacity that decreases resilience to a less supportive external environment, the dynamism of the population and economy suggests a brighter long-term future. All the major oil importers (Morocco, Tunisia, Egypt, Jordan and even Lebanon) have relatively flexible economies for their income levels and improving IT access, infrastructure and education. GCC countries such as the United Arab Emirates, Qatar, Bahrain and, to a lesser extent, Oman and Saudi Arabia have also increased innovation capacity via improved infrastructure and education.

Weakened states

Transitions have weakened oil importer balance sheets in countries such as Egypt, Morocco, Jordan and Tunisia. High and rising commodity prices, a weaker economic climate in Europe and policy uncertainty have stressed local balance sheets and weakened the private sector environment in the short term as governments have focused on consumption stimulus. At Roubini Global Economics, our systematic model shows that although Tunisia entered the Arab Spring with more resilience than Egypt (and as is the case with Morocco, continues to have a more flexible economy), its policy space has been eroded via rising fiscal and external deficits, and more recently inflation.

Even oil exporters are not immune: Iraq, Algeria and Libya have all been affected. North African oil exporters tend to be characterised by lower government effectiveness and weaker monetary and financial institutions than their importing peers or their wealthier GCC peers, limiting their ability to use the resources that they have. For example, political shocks have hit oil output in Libya and Iraq in 2013 as federal and regional squabbles have held production and exports hostage. Any decline in oil output puts their growth and fiscal balances at risk, given the vulnerabilities of the non-oil economy.

Our measures of political risk highlight that political violence has remained high in Algeria, Libya and Iraq, where 2013 civilian casualties have been the highest in four years, even as some of the economic metrics (external financing) improved. These political stresses suggest their governments will struggle to launch and maintain improvements in the business environment.  

In Iraq, prime minister Nouri al-Maliki’s focus on maintaining power and weakening any political opposition has turned his attention away from service delivery (power infrastructure), while political destabilisation has kept the government focused on the security issues that in turn justified the consolidative rule. 

Local focus

GCC policy has oscillated between short-term stabilisation and decade-long plans to develop and diversify domestic economies, employing more of the local population. More extensive government spending and new sovereign funds keep more revenues at home, supporting local growth and asset markets.

Initial GCC wage hikes sharply increased spending commitments, raising the risk that most of the GCC will run deficits in future. With oil prices flatlining in coming years and North American production rising, Saudi Arabia will struggle to meet its national employment goals, and infrastructure and new housing goals, with foreign workers tending to be placed in such roles. Ample reserves help buy time for some of the adjustments.

GCC regional involvement has also been somewhat short-termist, notably in Egypt where financial support bought time for the Egyptian government to avoid making difficult spending cuts. Unlike the IMF, European or US funds, the GCC conditionality is somewhat ambiguous. Policies including a preference to exclude hard-line Islamists from government could undermine the long-term stability of the country and the government’s ability to set policies.

Stabilisation comes first, but the self-reinforcing economic and political weakness suggests challenges converting aid into investment. Even GCC investors need clarity on the investment regime. Egypt’s debt and debt-service payments are crushing at almost 40% of gross domestic product by the end of 2014, meaning that a debt restructuring might be necessary.

GCC pump-priming has supported domestic debt and equity markets, which have outperformed other Mena and frontiers markets. GCC governments or quasi-sovereigns have sponsored sukuk to deepen local markets and help diversify corporate finance.

The reforms carried out to meet the mandates of global index provider MSCI will make it easier for foreign investors to take part, but we expect global correlations (vulnerability to global financial conditions) to increase. Other Mena markets will be driven by improvements in the policy stance and economic growth. Turning transition into a positive feedback loop may involve a series of short-term actions that help pave the way to a more sustainable future.

Supporting the real economy

So, what economic and policy steps could create a positive feedback loop for regional economies? First, facilitating domestic finance for the private sector by breaking the feedback loop between sovereigns and banks would allow banks to support the real economy. The Mena region is divided into countries where government spending and deposits can prime the pump of the banking system (for example, Saudi Arabia and Qatar) and thus fund development, and where banks are propping up the government (Egypt, Lebanon and Jordan, among others).

Putting the government finances on a more sustainable footing would help these banks support the private sector. In particular, dedicated pools of capital for SMEs would help solve some of the problems of access. Innovative new exchanges in the planning stages could provide additional capital. These could be amplified by improving the data on creditworthiness of borrowers (corporate and households), removing one argument against lending to new borrowers and avoiding a now prevalent scenario where many borrowers have multiple loans while others struggle to access the banking system.

The second step that regional economies can take towards creating a positive feedback loop is to refocus government spending. While current spending (wage hikes and subsidies) is popular, capital spending will help productivity. Mena governments tend to cut infrastructure spending and raise costs for business in times of stress; doing so may reduce the flexibility of their economies. Subsidies are a case in point – better targeting would free up space for capacity enhancements, offsetting transfers and potentially reducing inefficiencies. These reforms could go hand in hand with continued business environment reforms. This could be facilitated by regional and multilateral assistance, which could avoid having to make market-based and tougher adjustments.

Rachel Ziemba is director of emerging markets at Roubini Global Economics