Prepared by Gohar Abajyan, Mark Fischer, Amr Hosny, Gohar Minasyan, and Pritha Mitra (team lead).

Annex I. Medium-Term Economic Prospects in the MENAP and CCA Regions

Prepared by Gohar Abajyan, Mark Fischer, Amr Hosny, Gohar Minasyan, and Pritha Mitra (team lead).

Economic growth potential in the Middle East and Central Asia is slowing faster than in other emerging market and developing regions, dampening hopes of reducing persistent unemployment and improving generally low living standards in the region. The reasons go beyond declines of potential growth in the region’s advanced and emerging market trading partners; they are related to slowing productivity growth, declining worker participation, and especially in the Arab countries in transition, non-GCC oil exporters, and CCA oil importers, slowing capital investment. Policy priorities center on making the business environment more open and competitive, increasing public investment in infrastructure, reducing obstacles to labor market functioning, and nurturing worker talent. Improved access to finance and greater use of modern technologies play supporting roles. Together, these reforms can boost growth potential by 4 percentage points above current expectations—moving the region’s living standards closer to emerging market and developing country (EMDC) levels.

Medium-term economic prospects hinge on the region’s ability to expand production of goods and services for domestic and foreign markets. Such potential economic growth depends on how many people are employed in productive activities; on what physical capital they can use, such as buildings and machinery; as well as on the gamut of technological, structural, institutional, and policy factors that affect economic productivity—how many goods and services workers can produce using available machinery and other capital.1 The use of technological innovations, such as computer and information technologies, is an example of a factor driving economic productivity.

Potential growth is not directly observable but can be estimated through a variety of techniques, including statistical filters and production-function approaches.2 Uncertainties surrounding potential growth estimates are significant, especially for MENAP and the CCA, where statistics are incomplete and/or produced with a significant lag. To ensure the robustness of results, this annex uses several techniques to estimate potential growth. Although estimates vary across techniques, the relative potential growth rates across countries and regions, as well as the direction of their change over time, are consistent across techniques. Methodologies and estimates of potential growth in this annex are also broadly consistent with other recent studies (Cubeddu and others 2014). For oil-exporting economies, the focus here is on potential growth in the non-oil sectors, where such growth is currently driven largely by oil revenues (see Chapter 1). The annex also uses standard techniques to decompose potential growth into its underlying components (capital, labor, and economic productivity).

Potential Growth Is Slowing Faster Than in Other Regions

Potential growth rates vary widely across the MENAP and CCA. In particular, the economically less developed oil importers tend to have the lowest potential growth in the MENAP and CCA region (Figure A1.1)—well below the EMDC average. In contrast, the oil exporters—particularly in the GCC and CCA—have among the world’s highest non-oil potential growth, comparable to emerging and developing Asia. In part, high non-oil potential growth rates are driven by oil-financed government spending, often in the nontradable sector, and is not sustainable (see Chapter 1).

Figure A1.1
Figure A1.1

Non-Oil Potential GDP Growth

Sources: IMF, World Economic Outlook database; International Labour Organization, Global Employment Trends; and IMF staff estimates.Note: Red denotes CCA countries; blue denotes other countries; EE = emerging Europe; LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.1 PPP-weighted GDP used to calculate regional averages.2 Average across Hodrick-Prescott and Christiano and Fitzgerald filters and production function estimates. Mitra and others (forthcoming) provides details.

The global financial crisis led to a decline in potential growth in advanced and emerging market economies. Prior to the global financial crisis (during 2003–07), strong investor confidence led to the rapid creation of physical capital, innovation, and productivity growth across the world. As a result, EMDCs’ potential growth strengthened. The crisis sharply reversed these trends, and potential growth in both advanced and emerging market economies declined after 2008, as is well documented in earlier studies.3

A novel finding is that MENAP and CCA potential growth rates are slowing by more than in other EMDCs (Figure A1.1). The slowdown in potential growth is especially strong in the CCA oil importers, possibly because of their strong linkages to Russia, where the slowdown in potential growth is pronounced owing to inadequate physical infrastructure, overreliance on commodities, a weak business climate, and negative demographics.4 In the MENAP region (except the GCC), further loss of confidence amid intense conflicts in the region and in the aftermath of the Arab Spring in 2011 compounded the effect of the global financial crisis, leading to a sharp drop in potential growth just after 2010. In the GCC, the erosion of non-oil potential growth has been slightly offset by continued physical infrastructure investment financed by savings from high oil prices. Overall, declines in potential growth in the MENAP and CCA regions exceed the respective averages for EMDCs by ¾ of a percentage point over the next five years.

Reasons behind Declines in Potential Growth Vary

  • MENAP and CCA oil exporters (Figure A1.2). Continued infrastructure creation drives non-oil potential growth in the GCC and CCA oil exporters. These benefits are offset by declining contributions of labor and productivity, in part the result of reliance on abundantly available low-skilled foreign workers, cheap energy, and potential weaknesses in public investment quality, and absorptive capacity (IMF 2013). In some cases, relevant structural reforms have been initiated but will only bear fruit with long lags. In non-GCC MENAP economies, lower public spending (owing to a decline in oil export revenues in the aftermath of the global financial crisis and intensified conflicts) has lowered capital accumulation, employment, and potential growth.

  • MENAP and CCA oil importers (Figure A1.2). Outdated physical capital; inefficiency in using energy, capital, and talent; as well as weak global ties—inhibiting productivity that would result from adoption of the latest technologies, management techniques, and innovation—already limit potential growth. In the aftermath of the global financial crisis and the Arab Spring, strained public finances and lower investor confidence further reduced investment, in turn reducing the accumulation of physical capital and its contribution to potential growth. Cumbersome regulations, tax codes, and red tape tend to discourage productivity growth. Many countries have recently initiated reforms to address these obstacles, but reforms are frequently opposed by vested interests that have benefitted from highly concentrated private firm ownership (World Bank 2009a). In the MENAP oil importers, the workforce is young and not equipped with the skills needed for private sector jobs. Combined with the weak economic activity of recent years, this skills gap has raised unemployment so high as to discourage worker participation, lowering potential growth.5

Figure A1.2
Figure A1.2

Composition of Recent Non-Oil Potential Growth Slowdown

(Change in contributions from each factor of production, 2008–14 versus 2003–07, percentage points)1

Sources: IMF, World Economic Outlook database; United Nations International Labour Organization; national authorities; and IMF staff estimates.1 Proportions of factors from production function decomposition applied to average potential growth estimates across methods.2 Compares contributions for each factor of production, 2011–14 versus 2003–10.

What has not varied are the reasons why MENAP and CCA potential growth lags behind that of other EMDCs (Figure A1.3). Both before and after the global financial crisis, oil exporters’ productivity contributions to non-oil potential growth, lower than in EMDCs, have been offset by larger physical capital and worker contributions. Oil importers’ lower productivity has been compounded by lower contributions from physical capital than in EMDCs. These effects offset workers’ positive contributions to potential growth, reflecting young populations and, in the GCC, high availability of low-skilled foreign workers.6

Figure A1.3
Figure A1.3

Drivers of Differences in Non-Oil Potential Growth with Emerging Market and Developing Countries

(Percentage points)1

Sources: IMF, World Economic Outlook database; United Nations International Labour Organization; national authorities; and IMF staff estimatesNote: TFP = total factor production.1 Average potential growth of MENAP and CCA less that of emerging market and developing country average.

Boosting overall MENAP and CCA productivity and MENAP oil importers’ investment rates will be key to raising potential growth. A wide range of plausible annual productivity growth and investment-to-GDP ratio combinations—taking into account maximum plausible workforce growth—could raise potential growth.7 For example, ACTs could reach average EMDC growth in five years with their current annual investment-to-GDP ratio (22 percent) combined with an increase in annual productivity growth from zero to 1½ percent (Mitra and others forthcoming). This would be a start to raising employment and living standards; however, over the longer term, much higher potential growth will be needed in the Arab Countries in Transition, and in the rest of the region, to significantly improve the welfare of the majority of the population (Mitra and others forthcoming). Over time, greater female worker participation can also contribute, especially in MENAP economies. In oil-exporting economies, beyond raising productivity in the non-oil sector, it will be particularly important to raise productivity in areas where the sensitivity of non-oil potential growth to oil-related activities can be reduced.

Policies to Raise Potential Growth

A broad range of factors influence potential growth: macroeconomic (e.g., exchange rate, and trade and investment policies) and structural (e.g., reforms in financial and real sectors, labor and product markets, and political stability).8 Initial macroeconomic and sociopolitical conditions can help identify policies most likely to favor potential growth. For example, the results of efforts to increase the CCA workforce would be limited by already low unemployment and high male and female worker participation rates, and the GCC countries already have high rates of capital accumulation.

MENAP and CCA policymakers should focus on fostering worker talent, modernization of production methods, and recalibrating the role of the public sector to promote productivity growth (Figure A1.4). Cross-country regressions provide useful insights into policy priorities.9 Years of schooling have increased, but workers still lack the skills needed for private sector jobs. Adoption of modern production methods, including the use of the latest technologies, management techniques, and innovation,10 has been slow; low competitive pressures, reliance on low-cost foreign workers, cheap energy, monopolistic markets, or insufficient global integration may be factors. The government often has a dominant rather than supportive role. State-owned enterprises control the energy and banking sectors, whereas excessive red tape hampers private sector growth and perceived corruption discourages investment. In MENAP and the CCA, key policies that could turn the situation around include:

  • Enhancing worker talent. Public-private sector coordination in curriculum design can better align education with private sector needs. MENAP and CCA economies can also take advantage of large diasporas with platforms where emigrants abroad can share their knowledge and expertise with businesses at home. Some successful diaspora networks elsewhere are Foundation Chile, South African Network of Skills Abroad, and Thailand’s Reverse Brain Drain project.

  • Encouraging modern production methods includes applying technologies and management techniques that help firms efficiently use energy, capital, and worker talent, and eliminating policies that hamper innovation. Increased openness to noncommodity trade with fast-growing economies can help by fostering vertically integrated global manufacturing chains,11 which generate substantial technological and management spillovers.12 Attracting this type of foreign direct investment is facilitated by investment promotion, where information on business opportunities, laws, regulations, and factor costs is more effective than tax incentives and subsidized infrastructure such as energy (Harding and Javorick 2007).

  • A public sector that is supportive rather than dominant—that delivers basic services efficiently, promotes the rule of law and discourages corruption and fraud, and streamlines business regulations—would raise private sector productivity. Privatization of large state-owned enterprises could improve the quality of energy provision and banking services while reducing the government’s contingent liabilities.

  • High-quality infrastructure and a competitive business environment also foster technology-intensive foreign direct investment and modern production methods (see next section).

Figure A1.4
Figure A1.4

Contributions to Non-Oil Potential Growth

Sources: IMF, World Economic Outlook database; United Nations International Labour Organization, Global Employment Trends; World Bank, Doing Business Report; World Economic Forum, Global Competitiveness Report (2014); and IMF staff calculations. Mitra, Hosny, and Minasyan (forthcoming) provide details.

MENAP and CCA economies will also benefit from improving their business environments, financial development, and infrastructure—all essentials for physical capital accumulation (Figure A1.4). Globally, the MENAP and CCA oil importers—where investment constrains potential growth—rank low in these areas,13 which also pose obstacles for small and medium-sized enterprises across the regions. Key policies for raising investment-to-GDP ratios, and, in turn, physical capital, complementing some policies that also raise productivity (modernizing production and public sector roles, see the previous discussion), include the following:14

  • Creating a sound business environment calls for security, political and policy stability, strong protection of property and investors’ rights, and ease in starting a business. Eliminating various forms of corruption, including favoritism in government official decisions, and, in some cases, greater exchange rate flexibility and removal of capital controls, are also important.

  • Financial development could raise the availability and affordability of financial services that are critical to domestic capital investment, especially for small and medium-sized enterprises. Certain policies, against the backdrop of a sound banking system, can be potent (Annex III).

  • Public infrastructure investment, through higher quality and coverage, directly affects capital stock. Indirectly, it fosters private capital investment by providing more affordable and reliable inputs (especially for electricity) into production. Its effectiveness depends on the efficiency of public investment (Annex II). Over the longer term, large-scale investment could require foreign financing, especially in the CCA.

MENAP and CCA workforce growth is most affected by labor market efficiency and the work environment (Figure A1.4).15 The region’s labor markets are characterized by rigidities that contribute to stifling formal labor markets and fuel large informal sectors. Additionally, many MENAP and CCA economies lack the economic and political stability that is conducive to normal business operations. Policies to help overcome these obstacles include:

  • More efficient labor markets can increase worker supply and demand. Greater flexibility in wage-setting and hiring and firing policies (with unemployment benefits and protection against discrimination and arbitrary employer decisions) reduces firms’ costs and provides incentives for investment in firm-specific training. Complementary measures are explained in IMF (2014e). Flexibility also encourages worker productivity—it facilitates higher salaries and promotions, reducing incentives for the most talented workers to emigrate.

  • A healthy work environment that is safe, with reliable public transport infrastructure and economic and political stability, facilitates participation in the workforce.

  • Raising female workforce participation not only increases the size of the workforce but diversifies it, leading to greater innovation and productivity (Regional Economic Outlook: Middle East and Central Asia, November 2013).

Pursuing these policies could reverse declining MENAP and CCA potential growth and help the region converge toward higher EMDC living standards (Figure A1.5). In the GCC, the business environment and public infrastructure investment levels exceed the EMDC average, but some factors underlying productivity growth still fall short; raising their levels can raise productivity and potential growth. In the rest of MENAP and the CCA, potential growth can be raised by a comprehensive approach to these factors—closing large gaps with EMDCs in productivity, physical capital accumulation, and the workforce (e.g., worker talent, competitive business environment, efficient labor markets).

Figure A1.5
Figure A1.5

Medium-Term Growth above Baseline If Underlying Structural Variables Reach Emerging Market and Developing Country Levels1

Sources: IMF, World Economic Outlook; and IMF staff calculations.1 Potential growth derived if each of the factors underlying potential productivity (e.g., worker talent, modern production methods), capital (e.g., business environment, financial development), and labor (e.g., labor market efficiency, work environment) are increased to average emerging market and developing country levels. For simulation details see Mitra, Hosny, and Minasyan (forthcoming).

Annex II. Public Infrastructure Investment in the MENAP and CCA Regions

Prepared by Haonan Qu, Martin Sommer (team lead), and SeokHyun Yoon, with research assistance by Soledad Feal-Zubimendi and Juan Carlos Flores.

Infrastructure investment is an important precondition for economic growth. The GCC countries already invest massively in infrastructure, but non-GCC oil exporters and MENA oil importers invest considerably less than is warranted by their income levels. In the CCA, infrastructure investment is broadly consistent with fundamentals. The total identified shortfall in infrastructure investment is about US$72 billion annually. Raising infrastructure investment toward desirable levels could boost growth in the short term by some 3 percentage points among non-GCC oil exporters and about 1½ percentage points among the MENA oil importers. To increase infrastructure investment and its economic impact, policymakers need to improve public investment management and availability of the needed labor skills and finance.

MENA and CCA countries vary greatly in their infrastructure development, investment needs, and ability to meet attendant financing challenges. Most GCC countries have embarked on highly ambitious public infrastructure programs (Figure A2.1) with announced public investment projects that are multiples of annual economic output. In contrast, public investment has dropped sharply in non-GCC oil exporters and MENA oil importers—in some cases to half the peak values it reached during the 2000s. CCA public investment has been moderate but steady.

Figure A2.1
Figure A2.1

Public Capital Spending

(Percent of GDP)

Source: IMF staff calculations.Note: EMDC = emerging market and developing countries.

This annex considers estimates of infrastructure needs in MENA and CCA countries (including any reasons for differences across country groups), financing options, measures to increase public investment efficiency, and possible jobs and growth implications of higher public investment in underinvesting regions.

Infrastructure Gaps

Infrastructure development is usually tightly linked to income level (Figure A2.2);1 however, some countries appear to suffer from infrastructure gaps, defined as the deviation of infrastructure capital stock from the level warranted by the stage of economic development and other country characteristics such as the sectoral composition of output.

Figure A2.2
Figure A2.2

Infrastructure Quality and GDP per Capita1

Source: Albino-War and others (forthcoming).1 Infrastructure quality is measured using the infrastructure component of the Global Competitiveness Index. See Albino-War and others (forthcoming) for details.Note: GCI = Global Competitiveness Index.

Planned infrastructure expenditures in the GCC and CCA regions are broadly in line with infrastructure investment needs (Ianchovichina and others 2013). These estimates take into account additional country characteristics such as urbanization, technology, and a broader range of infrastructure subsectors; however, infrastructure investment plans lag behind in the MENA oil importers—including the Arab Countries in Transition—and particularly in the non-GCC oil exporters (Figure A2.3). The investment gap is estimated at 2 percent of GDP for the MENA and CCA countries as a whole, but most of this gap reflects the 6½ percent of GDP gap for non-GCC oil exporters and the 3 percent of GDP gap for MENA oil importers.2 These infrastructure gaps opened up for a variety of reasons that include limited fiscal space, crowding out of productive investment by high public sector wage bills and generalized subsidies (IMF 2014d), expectations of higher returns from financial assets than from infrastructure investment, and limited absorption capacity.3 Accumulation of infrastructure gaps can also partly reflect legacies of the global financial crisis as lower-rated countries face persistently tighter external financing conditions and a weak external environment. In some cases, extensive infrastructure damage resulted from military conflicts and protracted periods of underinvestment.

Figure A2.3
Figure A2.3

Public Investment and Physical Infrastructure Needs, 2014–19

(Percent of GDP)

Sources: IMF, World Economic Outlook database; Ianchovichina and others (2013); the Multilateral Development Bank Working Group on Infrastructure (2011); and IMF staff estimates.1 Estimates of infrastructure spending are based on the information from countries’ budget laws, when available, and IMF staff assessment. In the absence of estimates for a country, regional averages of infrastructure spending to total public capital spending ratios were computed to obtain total infrastructure spending.

Jobs and Growth Implications of Higher Public Investment

Public infrastructure investment could raise potential growth through capital accumulation and higher productivity. Calculations in this annex assume that policymakers make a temporary increase in public investment in non-GCC oil exporters and MENA oil importers by the amount of the annual infrastructure gap (US$72 billion).4 The assumed size of investment is within the range of scenarios discussed in the Arab Stabilization Plan White Paper (2012) (US$30–100 billion). Elasticities estimated in the October 2014 World Economic Outlook and Ianchovichina and others (2013) imply that the growth and jobs benefits of scaled-up infrastructure investment could be substantial (Figure A2.4); however, given the relatively low investment efficiency in most MENA and CCA countries and general capacity constraints (including insufficient domestic skilled labor), the short-term macroeconomic benefits could be at the lower end of estimated ranges:

  • Non-GCC oil exporters’ growth could increase by some 3 percent in the short term, while employment could increase by 2.8 million.

  • MENA oil importers’ short-term growth dividend could amount to about 1½ percent, with employment increasing by 1.6 million.

  • The growth impact for the MENA and CCA region would be about 1¼ percent, and employment could increase by 4.4 million jobs.

Figure A2.4
Figure A2.4

Impact of Higher Public Investment on Real GDP Growth


Source: IMF staff calculations.

Securing these favorable job and growth outcomes will require that public investment be highly efficient and fiscally sustainable. Infrastructure spending could be financed by reallocating spending from unproductive uses, or by securing additional external financing in parallel with domestic structural reforms.

Investment Efficiency

There is substantial scope to improve the efficiency of public investment in the MENA and CCA countries (Albino-War and others forthcoming; Dabla-Norris and others 2012). Greater efficiency would boost the growth dividend while saving financial resources. Albino-War and others (forthcoming) suggest that should MENA and CCA countries raise investment efficiency to the level of the best global performers, the productive infrastructure stock could be boosted significantly without any increase in public spending. Analysis of public investment management processes reveals that MENA and CCA’s related institutional quality outperforms sub-Saharan Africa and emerging Asia, but lags behind Latin America (Figure A2.5).5 MENA and CCA performance is particularly weak in the appraisal and selection stages of investment projects.

Figure A2.5
Figure A2.5

Public Investment Management Index,1 by Region

Sources: Dabla-Norris and others (2012); country authorities; and IMF staff estimates.Note: Compiled from 27 countries from sub-Saharan Africa (SSA), 8 from Asia, 10 from MENA and CCA, 9 from emerging Europe (EE), and 9 from Latin America and the Caribbean (LAC).1 An index that captures the institutional environment underpinning public investment management across four different stages: project appraisal, selection, implementation, and evaluation. A higher score reflects better public investment management performance.

Policy Implications

Job and growth gains from higher public investment can be substantial. Raising public infrastructure investment toward desirable levels could boost short-term growth in non-GCC oil exporters by some 3 percentage points and in MENA oil importers by about 1½ percentage points. However, limited capacity and underdeveloped investment frameworks pose challenges, reducing the macroeconomic benefits. To make the best of potential infrastructure investments, policymakers will need to focus on public investment management reforms, financing access, and labor market policies.

Public Investment Management

Successful country experiences suggest that developing strong institutions is crucial for fostering the efficiency of public investment. In the near term, countries could promote greater scrutiny of public investment projects, while preparing for more fundamental reforms of the public investment management process. Short-term measures would include increasing the transparency of key investment projects over the entire project cycle (for example, appraisal information, competitive procurement process, bidding statistics, cost/time overruns) and the budget process (for example, objectives, costs of projects, ex post evaluations). Over the medium term, countries should align investment projects with strategic country priorities and revamp the framework for managing public investment, including establishing independent checks of project appraisal and project selection.

Access to Financing

Financing capacities vary sharply across the region. Hydrocarbon exporters have generally stronger fiscal positions and easier market access than hydrocarbon importers. Sukuks are an increasingly popular financing option, especially in the GCC, but conventional financing through syndicated loans and bond issuances have fallen substantially since the global financial crisis (Figure A2.6). International financial institutions (IFIs) have boosted their lending, which reflects the new Arab Financing Facility for Infrastructure Investment (a joint project between the Islamic Development Bank and its partners), increased engagement by the World Bank, and Deauville Partnership efforts. Public-private partnerships (PPPs) continue to play a marginal role in the region, but initiatives such as the Arab Stabilization Plan aim to mobilize external capital for MENA infrastructure investments.

Figure A2.6
Figure A2.6

Financing for Infrastructure and Other Investments

(Percent of GDP)

Source: IMF staff calculations.Note: Includes also financing not directly used for infrastructure spending (e.g., certain FDI, bonds, and loans directed to noninfrastructure investments). FDI = foreign direct investment; IFI = international financial institution.

For countries with limited fiscal space and fewer financing options, the key questions are how much spending can be feasibly reallocated from unproductive uses toward investment and how much is available from external sources on fiscally sustainable terms. Untargeted subsidies and the public sector wage bill are potential areas for streamlining and reallocating spending in a number of countries.

External financing is often constrained by the challenging political and security environment. Over the long term, policies to develop domestic capital markets and institutions would help secure access to public infrastructure financing. Shorter-term policy options include mobilizing additional public revenue, providing financing support measures to attract more private sector involvement, designing a platform to strengthen IFI financing, and blending concessional and nonconcessional financing (Annex III). For example:

  • The World Bank’s Multilateral Investment Guarantee Agency credit enhancements for nonhonoring of financial obligations. The nonhonoring of financial obligations, available for up to 15 years, provides capital relief to commercial banks constrained by Basel rules, which could increase commercial banks’ lending capacity, allowing them to fund strong projects that are difficult to finance in traditional financial markets.6

  • Developing a platform to mobilize equity investment or grants from donors would strengthen IFIs’ infrastructure financing capability. The Islamic Development Bank’s private equity infrastructure fund (IIF) II is a good example. Following the successful implementation of IIF I (US$730 million), IIF II was launched in May 2014. IIF II targets Shariah-compliant investments in infrastructure projects in its member countries. It has already raised US$850 million, aiming for a target size of US$2 billion. This would help mobilize up to US$24 billion of aggregate financing to support the development of key infrastructure projects.

  • Donor countries are looking into new approaches that blend concessional and nonconcessional funding to assist low-income countries, given public pressure to reduce official development assistance and constraints on concessional lending by IFIs. These approaches use limited concessional resources to leverage nonconcessional funding, which helps raise the pool of resources for infrastructure development.

  • PPPs can be more efficient than traditional public procurement of assets and services, but entail substantial fiscal risks (IMF 2006b). These risks are particularly prevalent when PPPs are implemented by inexperienced governments, without adequate legal and institutional frameworks, or to bypass budgetary spending controls. Managing fiscal risks from PPPs could be achieved by adopting (1) investment planning systems to select sound projects and procurement options based on economic and efficiency considerations; (2) a legal and institutional framework with the appropriate structures and expertise to handle PPPs; and (3) fiscal accounting and reporting to allow the transparent disclosure and policy analysis of the fiscal implications of PPPs.

Labor Market

Finally, skills mismatches (World Bank 2009b) in domestic labor markets could hinder rollout of approved projects and job creation for citizens, while potentially encouraging the inflow of expatriates. Active labor market policies and structural reforms to address skills mismatches, to improve the skills of those already working, and to increase the number of people with education in technical fields would help increase the jobs and growth dividend of infrastructure investments.

Annex III. Access to Finance for Small and Medium-Sized Enterprises in the MENAP and CCA Regions

Prepared by Inutu Lukonga (team lead), Sami Ben Naceur, Gregory Hadjian, and Abdullah Al-Hassan.

The growth of small and medium-sized enterprises (SMEs) is critical to raising and diversifying economic growth and generating employment in the MENAP and CCA regions. However, deficiencies in the legal and financial infrastructure, poor SME financial reporting standards, and bankslending capacity constraints hamper SMEsaccess to finance. Further steps are therefore needed to strengthen legal and financial infrastructure, particularly credit and collateral registries, commercial courts, and bankruptcy regimes. Banks can enhance their capacity to lend by developing customized products tailored to SMEs, as well as by addressing weaknesses in their balance sheets and improving their risk management systems. Islamic finance holds promise for improving SME access to finance in the region, contingent on improvements in legal and financial infrastructure, and on development of appropriate SME products. Improving data on SMEs and funding gaps is critical for designing effective SME policies.

SMEs, Inclusive Growth, and Access to Finance

SMEs have been the engines of economic growth and employment for developed economies; they could also play an important role in generating inclusive growth in MENAP and the CCA, thereby reducing current income inequalities. In most of the member countries of the Organisation for Economic Co-operation and Development, SMEs account for more than 95 percent of enterprises and up to 70 percent of employment (http://www.oecd.org/statistics/). By contrast, while SMEs account for between 80 percent and 95 percent of formal sector enterprises in MENAP and the CCA, they only contribute about 30 percent of GDP and 20–50 percent of private sector employment. The contribution of SMEs to total employment is even lower in the MENAP oil-exporting countries because of the large share of public sector employees.

Limited access to finance for SMEs is one of the main obstacles to their growth in the MENAP and CCA regions. More than 50 percent of firms in the MENAP region do not have access to credit, and a third of firms identify lack of access as a major constraint. Although bank lending is the main source of financing for firms of all sizes, SMEs account for less than 8 percent of total lending, 13 percent for non-GCC countries, and about 2 percent for the GCC. A similar pattern is observable in the CCA, although the magnitudes vary (Figure A3.1).

Figure A3.1
Figure A3.1

Access to Finance: An Overview

Sources: Asian Development Bank (2013); European Investment Bank (2013); International Finance Corporation, IFC Enterprise Finance Gap database; IMF, Financial Access Survey; Organisation for Economic Co-operation and Development (2013a); World Bank (2010).Note: AE = advanced economies; CEE = Central and Eastern Europe; LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

Factors Constraining SME Access to Finance

SMEs’ limited access to finance reflects the interaction of demand, supply, institutional, regulatory, and other policy factors. The factors are also generic to both regions, except for the government crowding out, which is specific to some MENAP countries. More specifically:

  • Apart from obstacles arising from unfavorable investment climates, SMEs face several nonfinancial barriers related to their own capacities, including lack of financial accounts and unavailability of reliable credit histories.

  • Banks are reluctant to lend, or they may charge a higher risk premium or demand high collateral requirements from SMEs because of the perceived higher credit risk associated with information asymmetries and lack of collateral to cover this risk. Higher transaction costs discourage banks from lending to SMEs, but banks’ lending capacity is also constrained by their lack of customized products and risk management capabilities.

  • Financing alternatives outside the banking sector are limited. Nonbank financial institutions, such as microfinance institutions, leasing companies, and private equity or venture capital firms, which could also provide capital, are underdeveloped in both regions. Capital markets are developed in selected countries, but in most cases they do not include listings by SMEs which, in some cases, are precluded by stringent listing costs and disclosure requirements.

  • Nonperforming loans (NPLs) are high in many countries’ banking systems and have the potential to discourage lending in general, particularly to SMEs. Specialized financial institutions that were established to extend credit to SMEs have had only a limited impact, in large part because of governance problems, with many burdened with high NPLs.

  • Although banking systems are large, loan concentrations are high, reflecting the focus of banks on large borrowers. A lack of competition in some countries (for example, Algeria) has also contributed to low lending to SMEs, with large public banks specializing largely in lending to large state-owned enterprises and private banks focusing on the most profitable segments of large private businesses and trade finance.

  • In addition, large government financing needs crowd out the private sector in a number of MENA countries, particularly the Arab Countries in Transition.

Impact of Global Regulatory Initiatives

Financing of SMEs could face some headwinds from global regulatory initiatives, in the form of reduced availability of funding and increased cost of borrowing. Basel III requires banks to have tighter risk management, higher and better quality equity capital, and improved liquidity, including better matching of funding exposures. The increase in the leverage ratio, owing to the raising of the credit conversion factor for trade finance from 20 percent to 100 percent in Basel III can increase capital and drive up the cost of conducting trade finance. The likelihood that SMEs in MENAP and the CCA will bear the brunt of the adjustment in lending is high: SMEs carry higher risks, and, particularly in these regions, are concentrated in trade and construction. Moreover, the costs of due diligence needed to comply with anti-money laundering/combating the financing of terrorism regulations and the United States’ Foreign Account Tax Compliance Act is also leading some international banks to withdraw correspondent relations with banks in the MENAP region and to curtail lending to SMEs in the region.

Recent Reforms

Promoting access to finance for SMEs has been on the global reform agenda since the global financial crisis, and on the national agendas of most MENAP and CCA countries. However, the reforms have had only a moderate impact on improving access to finance, in large part because they have been partial, incomplete, or ineffective. Table A3.1 indicates areas where countries have implemented reforms, and Figure A3.2 compares the progress made by the two regions.

Table A3.1.

Reforms and Institutional Arrangements to Enhance SME Access to Finance

article image
Sources: World Bank, 2014 Doing Business Survey; and country authorities.Note: n.a. = data not available; SME = small and medium-sized enterprise.
Figure A3.2
Figure A3.2

Indices for Legal Rights and Credit Information

Sources: World Bank Doing Business, 2006 and 2014; and country authorities.Note: LAC = Latin America and the Caribbean; OECD (HI) = Organisation for Economic Co-operation and Development high-income countries; SSA = sub-Saharan Africa.
  • In the MENAP region, the focus has largely been on strengthening credit information systems that enable lenders to assess borrower creditworthiness and providing subsidized credit and other financial support. Less progress has been made with reforms related to property transfer registration that facilitates collateral-based lending; protecting minority shareholders, which is needed to improve the ability of companies to raise capital; or strengthening the insolvency regime and the efficiency of the judiciary system to help enforce contracts and protect lenders in insolvency. World Bank reports indicate that none of the countries in the region have laws that comply with modern international best practices, and in most countries bankruptcy is criminalized. In addition, while many countries have established credit registries, the coverage of the credit registries is limited in MENAP countries.1 Subsidized credit, provided through specialized financial institutions, has met with limited success because of weak corporate governance that has resulted in high NPLs. Credit guarantee schemes (CGSs) are reported to have been ineffective.

  • The CCA countries, by contrast, have implemented reforms that more comprehensively cover property registration, credit information, protection of investors, enforcing contracts, and insolvency regimes. The coverage of credit registries is also much higher. CGS and financial support programs have been implemented in a few countries. Leasing has expanded more rapidly, driven by foreign European banks and regulatory arbitrage in some cases.

For both regions, the lack of quantitative, up-to-date, and consistently monitored data for the size of the SME segment and the magnitude of SME funding gaps remains an obstacle to a better understanding of the SME sector in the region and to development of appropriate policies. Although enterprise surveys have somewhat improved the availability of data on formal SMEs, important gaps remain in the data needed to evaluate the needs of the sector, to assess progress and thereby provide a basis for a better-informed public discussion, and to help with evaluating the effectiveness of government policies and programs.

Islamic Finance

The Islamic finance industry has attracted the attention of policymakers as a way to expand financial inclusion and tap into excess savings to finance investment. According to the International Finance Corporation (2014), there is a huge demand for Islamic products among SMEs in the MENAP region, where approximately 35 percent of such businesses are excluded from the formal banking sector because of a lack of Shariah-compliant products.2 The funding shortage is most acute in countries such as Morocco, Pakistan, and Saudi Arabia,3 where local SMEs are reluctant to consider conventional banking alternatives, In addition, a number of Islamic financial products are suitable for expanding credit to SMEs, especially participatory schemes such as mudarabah (profit sharing) and musyarakah (joint venture), which allow Islamic banks to lend on a longer-term basis to projects with higher risk-return profiles, and leasing, which circumvents the problem of collateral.

However, Islamic banks have not capitalized on this latent demand: their assets predominantly consist of debt-like products such as murabaha. The potential to significantly narrow the SME funding gap is limited by a number of factors. First, as with conventional banks, credit risk concerns limit the Islamic banks’ exposure to SMEs against the backdrop of weak financial infrastructure relating to credit information systems and insolvency regime. In addition, to tap the underlying potential, Islamic banks need to build capacity and develop Shariah-compliant products to cater to SMEs. Second, unlike risk management in conventional banks, risk management in Islamic banks remains comparatively weak, and the regulatory environment in many countries is not yet tailored to Islamic finance. There is also a shortage of expertise in Shariah rules and courts that are conversant with Shariah jurisprudence to adjudicate in commercial cases.

Empirical studies that have assessed the impact of Islamic finance on access also show positive, but limited, evidence of an impact of Islamic banking on financial access. AbuShanab and others (forthcoming) examined the degree to which a greater presence and/or activity of Islamic banks affected financial access and depth. The econometric analysis found a weak correlation between Islamic banking assets and access to finance. These results are consistent with the findings of a 2013 World Bank study (Demirgüç-Kunt, Klapper, and Randall 2013) on financial inclusion, which suggests that increasing the number of Shariah-compliant financial institutions can make a positive difference to the operations of small firms in Muslim-populated countries by reducing barriers to formal services.

Policy Recommendations

The factors constraining access have been well identified, and the challenge for countries has been to create an enabling environment. A comprehensive strategy is needed:

  • Reforms to improve legal and financial infrastructure need to be expedited. Recent reforms have been uneven and partial, failing to address the lingering deficiencies in the legal and financial infrastructure, particularly the need to improve coverage of credit registries, ensure effective operation of commercial courts, and enact and enforce insolvency regimes. Addressing infrastructure constraints is also critical for increasing the penetration of Islamic financial products.

  • Financial institutions need to develop customized products for SMEs. Banks’ business models need to be better tailored to SME lending and risk management. Public-private partnerships, including partnerships with international financial institutions, can help in this regard, through training and technical support. Islamic finance can help improve SME access to finance in countries where segments of the consumer market do not demand financial products for religious reasons, but for Islamic banks, as for conventional banks, increased credit supply will require an enabling environment.

  • Development of the nonbanking sector could help ease funding constraints. Development of suitable alternatives to bank finance, particularly leasing and factoring, could also help increase access to finance for SMEs. Alternative listings on capital markets that require less stringent disclosure requirements could also open venues where SMEs could raise long-term capital.

  • Careful use of credit guarantee schemes might help. Financial infrastructures address constraints related to collateral-based lending, but where collateral is lacking there is also a need to consider introducing CGSs where these are absent, and improving their operations where they already exist. Identification of factors that have rendered CGSs ineffective will be key.

  • Better data collection on SMEs’ access to finance is needed. Data would help policymakers and financial institutions to better understand the needs of the sector and to develop more targeted support measures. Computerized business registries would further facilitate the data-gathering process, and would serve as an important first step for firms joining the formal sector. Annual business and financial reports can provide important measures over time on the size and trends of the SME sector.

Finally, although financial access is critical for SME growth, its expansion should not be achieved at the cost of financial stability: hence, these reforms need to be accompanied by steps to improve financial supervision. Another supporting policy is fiscal prudence: reducing the crowding-out of the private sector by government borrowing can act as a relevant driver for banks to increase SME lending.

Annex IV. Measuring Inclusiveness in the MENAP and CCA Regions

Prepared by Amine Mati (team lead), Davide Furceri, and Younes Zouhar, with research assistance by Brian Hiland and Jonah Rosenthal.

Poverty rates and income inequality have declined in the MENAP and CCA regions over the past two decades. The size of the middle class has remained significant in both regions but has grown much more slowly in MENAP oil importers than in the CCA and other countries. Access to services, including water, electricity, education, and finance, as well as employment opportunities, are also considerably lower in MENAP oil importers. Some economic groups, such as youth and women, are particularly disadvantaged in this regard. Land-based income distribution remains unequal, especially in the CCA and also in MENAP, where many countries have large rural populations.

Mixed Performance on Poverty, Inequality, and Middle Class Size

Poverty rates in the MENAP and CCA regions have steadily declined over the past decade and are among the lowest in the developing world. Based on the international poverty line of 2 PPP per day, poverty rates in the CCA and MENAP oil importers declined by 14 percentage points and 9 percentage points between the 1990s and 2000s, to 24.3 percent and 32.8 percent, respectively (Figure A4.1).1 These rates are well below those in developing Asia and sub-Saharan Africa, but above poverty rates in Latin America. This regional assessment masks heterogeneity across countries; however, poverty rates in MENAP oil importers vary from a low of 10 percent in Tunisia to a high of 64 percent in Pakistan. In Egypt, the poverty rate increased from 16.7 percent in 2000 to 21.6 percent in 2009 and 26.3 percent in 2013. Moreover, many people in MENAP oil importers and the CCA remain at a high risk of falling into poverty, as 14.5 percent and 11 percent of populations, respectively, live on incomes that are just above the international poverty line (between US$2 and US$2.5).

Figure A4.1
Figure A4.1

Population Living on $4 or Less, 2000–10

(Average, percent)

Source: World Bank, World Development Indicators database.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

Indicators of income inequality in MENAP and CCA countries have improved over the past decade. The population-weighted Gini index for the CCA region decreased from 39.3 in 1990s to 35 in the 2000s, while remaining stable in MENAP oil importers at 33 (Table A4.1).

Table A4.1.

Measures of Inequality

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Note: The relative income shares are calculated as a ratio of the income share of the top quintile to that of the bottom quintile. Population-weighted averages. LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

The relative income shares of the top and bottom quintiles are also the lowest in MENAP oil importers and the CCA. These data, however, may suffer from measurement problems (see Alvaredo and Piketty 2014; Verme and others 2014), for example, because upper-income households are underrepresented in the household surveys (see United Nations Development Programme 2011). The land ownership concentration measured by the Gini index points to a more unequal distribution, especially in countries with a large rural population (Figure A4.2). These findings are broadly consistent with a widely held view that high inequality and perceptions of exclusion (see more on this in the next section) were a key cause of the social turmoil in the Arab Countries in Transition.

Figure A4.2
Figure A4.2

Land Gini Index

(Weighted average)

Source: United Nations Food and Agriculture Organization.Note: Regional averages based on one observation per country, obtained between 1996 and 2006. LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

The middle class has remained significant in MENAP oil importers and the CCA, despite a slower expansion during the past decade in MENAP oil importers than in the CCA and other regions of the world. There is no strong evidence that the middle class has been “hollowing out” over the years in MENAP oil importers and the CCA. By most common measures,2 the middle class in the CCA, and to a lesser extent in MENAP oil importers, comprises the largest proportion of the population (Table A4.2). However, the middle class in MENAP oil importers has been growing at a slower rate than that in the CCA and developing Asia. The upper middle-income class has remained small in MENAP oil importers while expanding significantly in other regions.

Table A4.2.

Size of the Middle Class Using Alternative Definitions

(Percent of population)1

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Source: IMF staff calculations based on World Bank Poverty database.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

Regional averages weighted by population.

Daily income between US$2 and US$13 in 2005 PPP$.

Daily income between US$2 and US$20 in 2005 PPP$.

Daily income between US$4 and US$10 in 2005 PPP$.

Daily income between US$10 and US$20 in 2005 PPP$.

Daily income between US$10 and US$50 in 2005 PPP$.

Income between 75 percent and 125 percent of the national median.

Low Growth and Access to Services in MENAP Oil Importers

Lackluster growth in MENAP oil importers hurts inclusiveness by hampering social development, poverty reduction, and improvement in living standards. Despite increasing by about 50 percent between the 1990s and 2010s, GDP per capita (based on 2011 PPP) in MENAP oil importers has been well below levels observed in other regions, except sub-Saharan Africa (Figures A4.3 and A4.4). This underperformance reflects both low economic growth and rapid population growth. By comparison, during the same period, GDP per capita more than doubled in the CCA, allowing this region to catch up with Latin America. While GDP per capita is the highest in MENAP oil exporters, its growth rate is the lowest, in part reflecting these economies’ dependence on oil and gas.

Figure A4.3
Figure A4.3

GDP per Capita

(PPP, Constant 2011 International Dollars)


Source: World Bank, World Development Indicators database.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.
Figure A4.4
Figure A4.4

GDP Per Capita Growth

(PPP, Constant 2011 International Dollars)

(Percentage change)

Source: World Bank, World Development Indicators database.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

Access to services such as water and electricity is low in MENAP oil importers, and the region lags behind its peers in educational attainment and access to finance. The share of the population deprived of access to education and health and experiencing low standards of living—also known as “multidimensional poverty”3—stayed at 33 percent in MENAP oil importers during 2000–10, among the highest in the world, and well above the levels observed in the CCA (3.1 percent), Latin America (8.3 percent), MENAP oil exporters (23.5 percent), and developing Asia (26.7 percent) (Figure A4.5). MENAP oil importers are also performing poorly in educational attainment; despite some progress, average years of schooling stand at 5.5 years, only slightly better than in sub-Saharan Africa and much worse than in other regions of the world (Figure A4.6). Low access to bank services, with the number of bank branches per 100,000 adults averaging less than a third of that in Latin America, continues to hamper social and economic development in MENAP oil importers (Figure A4.7).

Figure A4.5
Figure A4.5

Population Living in Multidimensional Poverty

(2013; percent)

Source: United Nations Development Programme, Multidimensional Poverty Index.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.
Figure A4.6
Figure A4.6

Educational Attainment

(Average years of schooling for population age 15+)

Source: Barro-Lee dataset.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.
Figure A4.7
Figure A4.7

Access to Bank Services

(Number of commercial bank branches per 100,000 adults)

Source: World Bank, World Development Indicators database.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

Lack of Employment Is a Key Inclusiveness Problem

The MENAP and CCA regions have some of the lowest employment-to-population ratios in the world. In MENAP oil importers, in particular, employment rates hover at about 43 percent at present. This compares poorly with other developing regions, where similar ratios range between 60 percent (Latin America) and 67 percent (sub-Saharan Africa) (Figure A4.8). There is, however, considerable variation within both the CCA and MENAP regions. In the CCA, employment-to-population ratios range from 54 percent in Turkmenistan to 68 percent in Kazakhstan, whereas in the MENAP they range from 32 percent in Jordan to 86 percent in Qatar. In addition, more than one-third of those employed in MENAP oil importers are “vulnerable” (either self-employed or working as contributing family workers) (Hakimian and others forthcoming), contrasting with the almost negligible share of “vulnerable” employed in MENAP oil-exporting countries such as Kuwait, Qatar, and the United Arab Emirates.

Figure A4.8
Figure A4.8

Employment-to-Population Ratio

(Regional average for corresponding years using available data)

Source: International Labour Organization, Key Indicators of the Labor Market.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

High unemployment rates, particularly among the youth, mirror low employment rates. In MENAP oil importers and the CCA, unemployment rates have been consistently in double digits during the past 20 years, and they continue to exceed the rates for other developing regions (Figure A4.9). For the youth, they are particularly high, persistently exceeding 20 percent in MENAP and the CCA—well above the rate in other regions such as developing Asia (10 percent) and sub-Saharan Africa (15 percent) (Figure A4.10). These statistics have not improved significantly in recent years, in part because the recovery has been weak. Youth unemployment rates are highest in Mauritania (45 percent) and above 30 percent in many MENAP and CCA countries, particularly Armenia, Egypt, Georgia, Iraq, Jordan, and Yemen.

Figure A4.9
Figure A4.9

Unemployment Rate

(Decade averages, percent)

Source: International Labour Organization, Key Indicators of the Labor Market.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.
Figure A4.10
Figure A4.10

Youth Unemployment Rate

(Regional average, percent)

Source: International Labour Organization, Key Indicators of the Labor Market.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

The previous evidence suggests that labor market performance in the MENAP and CCA regions—particularly in MENAP oil importers—remains weaker than in other regions of the world. These economies have not been able to translate economic growth into employment opportunities. This conclusion is corroborated by evidence on the employment-output elasticities (that is, the net new job creation for each percentage point change in GDP). In particular, the evidence presented in Crivelli, Furceri, and Toujas-Bernaté (2012) suggests that the employment intensity of growth in MENAP oil importers has been among the lowest in the world (0.1)—only a notch higher than in sub-Saharan Africa.

Acute Gender Inequality in MENAP

Labor force participation rates in MENAP are among the lowest in the world (Figure A4.11).4 Within the region, there is significant heterogeneity. Labor force participation rates in MENAP oil exporters have been rising and currently stand at the levels of other developing regions (about 60 percent). In MENAP oil importers, they have remained stable at about 50 percent. By contrast, participation rates in the CCA have been in line with those of developing Asia and Latin America.

Figure A4.11
Figure A4.11

Labor Force Participation Rate

(Regional average for corresponding years, percent)

Source: International Labour Organization, Key Indicators of the Labor Market.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

The low labor force participation rates in MENAP mainly reflect very low female labor force participation rates—the lowest among developing regions. In particular, the female-to-male labor participation rate in MENAP, even though it has been improving over the past two decades, is only about 27 percent compared to more than 65 percent in other regions (Figure A4.12). Extremely low female-to-male labor participation rates are recorded for Afghanistan and Syria (less than 20 percent), followed by Algeria, Iran, Iraq, Jordan, and Saudi Arabia (all below 35 percent).

Figure A4.12
Figure A4.12

Female-to-Male Labor Force Participation

(Number of females participating per 100 males)

Source: International Labour Organization, Key Indicators of the Labor Market.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

Gender disparities are also evident in women’s access to health, education, and economic opportunities more broadly. These different aspects of gender disparities are summarized in the World Economic Forum’s Gender Gap Index (see Figure A4.13).5 Two striking features emerge:

  • Gaps in the MENAP regions are among the widest in the world—the index score is well below that of other developing regions, including the CCA.6

  • Gaps for MENAP oil importers have widened in recent years. There is, however, important heterogeneity within the region: (1) gaps are particularly wide in Pakistan, Syria, and Yemen, whereas in Jordan and Lebanon they are not significantly different from those of other regions; and (2) gaps have widened in Syria over the past decade, and improved markedly in some countries (for example, Egypt).

Figure A4.13
Figure A4.13

Global Gender Gap Index, 2006–13


Source: World Economic Forum, Global Gender Gap Report (2013).Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

Regional inequality in access to basic services is also present in the MENAP region. One important aspect of inclusiveness is how access to basic services (water and sanitation) is shared across regions in a given country:

  • The rural-to-urban ratio for access to improved water sources is, on average, similar in the MENAP and CCA regions to that in most other developing regions, and is significantly better than in sub-Saharan Africa (Figure A4.14). However, these broad trends mask important differences across countries, particularly in the MENAP oil-importers group, where the ratio of rural-to-urban populations with access to improved water sources ranges from less than 62 percent in Afghanistan to 100 percent in Lebanon.

  • The rural-to-urban ratio for access to improved sanitation facilities is among the lowest in the world for MENAP oil importers, and is higher only than that in sub-Saharan Africa (Figure A4.15). This contrasts with the experience of MENAP oil exporters and the CCA, where significant improvements have been made over the past two decades and the rural-to-urban ratio of access to improved sanitation facilities is now among the highest in developing regions.

Figure A4.14
Figure A4.14

Rural-to-Urban Access to Improved Water Source

(Number of rural persons with access for every 100 urban persons with access)

Source: World Bank, World Development Indicators database.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.
Figure A4.15
Figure A4.15

Rural-to-Urban Access to Improved Sanitation

(Number of rural persons with access for every 100 urban persons with access)

Source: World Bank, World Development Indicators database.Note: LAC = Latin America and the Caribbean; SSA = sub-Saharan Africa.

Toward Better Outcomes

Although the diagnostic shows many encouraging outcomes, there is a clear need for policies to address areas in which inclusiveness can be improved. Poverty rates have been falling and income inequality has declined, but high unemployment and low labor force participation remain areas of concern in many countries. In addition, access to services such as electricity, water, education, and finance is lagging. Some groups, such as women, youth, and rural populations, remain particularly disadvantaged.

Raising economic growth would strengthen employment prospects. Higher rates of sustained economic growth would generate more jobs and provide incentives to enter the labor force, including for women and youth. Policies to strengthen growth will vary among countries but would often include creating fiscal space to increase priority spending (health, education, infrastructure), and policies to increase trade integration, improve the business climate, and reform labor markets.7

Special emphasis is needed to promote wider access to services. A strengthened focus on the quantity and efficiency of public investment is needed to address major gaps in the provision of electricity, water, and education (Annex II). Access to finance can be improved by expediting reforms of legal and financial infrastructures, developing customized products for small and medium-sized enterprises, expanding the nonbank financial sector, and providing carefully designed credit guarantee schemes (Annex III).

Countries need to give particular attention to excluded groups. For instance, female labor participation can be encouraged by improving access to, and quality of, education for girls, legislative reform to ensure equal opportunity in employment, ensuring equal pay for equal work, and providing adequate parental leave and affordable childcare facilities (see Box 1.3 in the November 2013 Regional Economic Outlook). Policies to ease youth unemployment can include targeted active labor market policies, including training and counseling for labor market entry and internship schemes to smooth the transition from school to work. Where gaps between rural and urban populations regarding access to services are wide, public investment can be targeted to disadvantaged regions.

Annex V. Economic Cooperation and Integration in the CCA

Prepared by SeokHyun Yoon, with research assistance by Soledad Feal-Zubimendi.

Economic cooperation and integration, within the CCA and with other regions, can help CCA countries leverage their comparative advantages, gain access to larger and faster growing markets, and reduce high trade costs. However, bilateral or narrowly focused initiatives risk diverting trade and weakening economic prospects of the region. CCA countries would benefit from liberalizing their restrictive trade regimes on a multilateral basis within the World Trade Organization (WTO) framework, while continuing to foster regional economic cooperation and integration. As CCA countries open up to trade, they may need to adjust their macroeconomic policies to make their economies less vulnerable to external shocks.

Rationale for Economic Cooperation and Integration in the CCA

Economic cooperation and integration can promote growth. CCA countries share many economic challenges: being landlocked, difficult terrain, underdeveloped infrastructure, and a legacy of extensive public sector involvement in their economies. However, there is also considerable diversity in economic size, development levels, energy and water endowments, and economic policy regimes. Diversity and heterogeneity across the CCA can be a source of dynamism for economic cooperation and integration.

Greater economic cooperation and integration have several potential benefits:

  • Lower trade barriers, by developing economic corridors and improving transport connectivity to reduce transportation and cross-border costs would likely increase trade and expand product diversity, and encourage liberalization of markets for services.

  • Greater diversification and larger markets would increase domestic competition, facilitate innovation, and contribute to building cross-border production chains. These, in turn, would increase exports outside the region and enhance job opportunities.

  • Strengthened financial linkages would provide better opportunities for consumption smoothing (trade finance), efficient capital allocation (foreign direct investment), and reliable financial services (international payments).

  • Resolution of regional issues such as labor migration and water access. With a substantial number of migrants from the CCA region seeking employment in the better-off economies, both within (Kazakhstan) and outside the CCA (Russia), economic cooperation and integration could contribute to the reduction or removal of informal and institutional barriers to labor migration. Regional approaches to the water-energy nexus could also bring major benefits, reducing the potential for conflict through more efficient management and more reliable availability of these scarce resources.

  • Greater unification of standards and locking-in of structural reforms. Economic and social benefits from economic cooperation could reinforce economic reforms and political commitment to anticorruption and good governance. This would, in turn, help generate the political momentum for further domestic reforms. Friendly competition and benchmarking among CCA countries would provide a further impetus.

Status of Economic Cooperation and Integration in the CCA

In many respects, the CCA economies recognize that multilateralism formalized by WTO membership provides a strong framework for developing international economic relations. CCA countries have pursued accession to the WTO to gain better access to markets in developed countries, though progress has been slow. Armenia, Georgia, the Kyrgyz Republic, and Tajikistan are members of the WTO, and Kazakhstan’s accession is expected soon. Azerbaijan’s accession is advancing, while the accession processes of Turkmenistan and Uzbekistan are at an earlier stage.

Other efforts have been made to improve regional links, with signs that regional cooperation gained a new impetus in recent years.

  • Eurasian Economic Union (EEU). Comprised of Belarus, Kazakhstan, and Russia, the EEU will become effective in January 2015, building on the Eurasian Economic Community established in 2000 and the Eurasian Customs Union (ECU) formed in 2010. Armenia and the Kyrgyz Republic are expected to join in the near future. The EEU envisages the free movement of goods, services, capital, and labor among the member countries. The initiatives followed earlier efforts: the Eurasian Development Bank was established in 2006 to finance the development of regional resources and infrastructure, and the Anti-Crisis Fund was formed in 2008 to support efforts by countries in the region to address the fallout from the global financial crisis.

  • Central Asia Regional Economic Cooperation (CAREC). Emerging from a regional initiative in 1997, the current membership consists of Afghanistan, Azerbaijan, China, Kazakhstan, the Kyrgyz Republic, Mongolia, Pakistan, Tajikistan, Turkmenistan, and Uzbekistan. Focused on the development of regional trade, transport, and energy corridors, CAREC aims at promoting and facilitating regional cooperation. The participation of multilateral institutions, such as the Asian Development Bank, is a unique aspect of CAREC, allowing cooperation and coordination not only among the member countries but also among key international financial institutions involved in the region.

  • Shanghai Cooperation Organization (SCO). This organization was established in 2001 by China, Kazakhstan, the Kyrgyz Republic, Russia, Tajikistan, and Uzbekistan. Although principally focusing on regional security concerns, the SCO added regional economic development and cooperation to its goals in 2003.

Advancement of economic cooperation and integration under existing international agreements, however, faces a number of challenges.

  • EEU: Early evidence suggests that many challenges prevent member countries from reaping the full benefits of the customs union and enhanced economic integration, because of asymmetry in the economic size of the member states and high common external tariffs (CETs). Kazakhstan’s GDP is about one-tenth of Russia’s, and Belarus’ GDP is one-third of Kazakhstan’s. The significantly higher ECU CETs (the simple weighted average of 9.2 percent) could lead to a significant increase in the tariffs of prospective member countries, leading to trade diversion.1

  • CAREC: Despite some progress in physical infrastructure in the areas of regional connectivity and access to energy and water, progress has been slow in the areas of improving legal and regulatory aspects of trade, transport, and energy sector management. Moreover, links between the regional CAREC and national sector strategies have been weak.

  • SCO: This organization deals primarily with regional security issues, while issues of economic integration receive less attention, a reflection of differing views and interests on key issues of regional oil and gas transit. The SCO’s decision-making rule is based on principles of consensus and noninterference, which has its limitations in resolving conflicts among members, such as border crossing and regional water management issues.

In practice, gains from increased market size through economic integration are yet to fully materialize. Although the CCA has made significant progress in integrating with the rest of the world, intraregional trade has yet to catch up. The share of intraregional trade in the CCA relative to the region’s overall global trade dropped significantly over the past two decades and did not keep pace with rapid economic growth in the region (Figures A5.1 and A5.2). Lower intraregional trade in the CCA contrasts with that of the rising numbers among the Association of Southeast Asian Nations (ASEAN) countries. CCA economies benefit from trade with two major trading partners, China and Russia (and for some CCA countries, the European Union), more than from trade within the CCA (Figure A5.3).

Figure A5.1
Figure A5.1

Intraregional Trade

(Percent of total trade)

Sources: IMF, Direction of Trade Statistics database; and IMF staff calculations.Note: ASEAN = Association of Southeast Asian Nations.
Figure A5.2
Figure A5.2

CCA’s Share in the Global Economy


Sources: IMF, World Economic Outlook database; and IMF staff estimates.
Figure A5.3
Figure A5.3

CCA: Trade Composition Change Between 2000 and 2013

(Percent of total)

Source: IMF, Direction of Trade Statistics database.

The CCA’s trade with China has grown rapidly in recent years. China has become the main trading partner of the CCA countries, overtaking Russia and the European Union. China’s economic growth and rising energy needs explain the expansion of Chinese engagement with the CCA countries, whose trade with China increased over the past decade, mainly reflecting increased exports of oil and gas, agricultural products, and raw materials from the CCA to China and increased CCA imports of manufactured, mostly consumer goods. Nevertheless, Russia remains an important destination for some goods, such as garments and spirits, from the CCA’s job-creating manufacturing industries and a source of manufactured imports for the CCA (Table A5.1).

Table A5.1.

CCA: Trade Shift from Russia to China

(Percent of CCA GDP)

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Sources: Comtrade database; and IMF staff calculations.

Several Factors Explain the Slow Pace of Regional Integration

  • CCA economies have similar product structures. CCA countries in each subgroup export roughly the same set of goods, and most of these goods are either commodities or minerals. Exports are also concentrated on a few destinations (Figures A5.4 and A5.5). By contrast, in the ASEAN region, intermediate goods account for as much as 40 percent of intra-ASEAN trade, with a high degree of product chain dependence on Japan and China.

  • Intraregional trade costs remain high. Most CCA countries face difficult geographic and climate barriers, leading to high cost of transportation and communication, as well as extended transit and delivery times, including time waiting at borders. In addition, limited and poor physical infrastructure adds to the cost of trade (Table A5.2).

  • Progress in removing cross-border obstacles has been slow. The 2014 World Bank Doing Business Indicators rank most CCA countries, with the exception of Georgia, near the bottom on indicators of barriers to cross-border trade.2 This ranking reflects cumbersome procedures and red tape in the processing of import and export documents.

Figure A5.4
Figure A5.4

Selected CCA: Export Composition


Source: United Nations Comtrade database.
Figure A5.5
Figure A5.5

Selected CCA: Export Share to Top Three Trading Partners1

(Percent of total exports)

Source: United Nations Comtrade database.1 Top three trading partners vary across countries.
Table A5.2.

Intraregional Trade Costs

(Tariff-equivalent trade costs in 2007)

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Source: UNESCAP, Intra-regional Trade Costs in Asia, 2010.Note: CCA (for this table: Armenia, Azerbaijan, Georgia, Kazakhstan, and the Kyrgyz Republic); SAARC (Bangladesh, India, Pakistan, and Sri Lanka); ASEAN (Indonesia, Malaysia, Philippines, and Thailand); East Asia (China, Japan, Korea, and Mongolia); EU5 (France, Germany, Italy, Spain, and the United Kingdom).

Other institutional factors also hamper economic cooperation. Tensions among CCA countries, including disputes over territory (Nagorno-Karabakh) or water and energy resources (Tajikistan and Uzbekistan) have hampered economic cooperation in the past and may be difficult to overcome in the future. Also, challenges in the areas of accountability and corruption have made it difficult to create enabling business environments.


The success of economic integration in the CCA will depend on how cooperatively all key trading partners can be involved: China, the European Union, and Russia. Prospects for broader integration and the CCA’s emergence as a “land bridge” on the Eurasian continent will depend on collaboration not only among the CCA countries, but also among the region’s important neighbors. So far these have tended to pursue “exclusive” cooperation initiatives with the region. Russia has recently set up a development fund of US$1 billion for the Kyrgyz Republic as part of plans for the latter to join the EEU. Large-scale Russian financial support for energy and other infrastructure projects was also discussed when Armenia decided to join the ECU in 2013. China has also expanded economic agreements with many CCA countries for investment, especially in the energy sector. Concerns about cross-border issues and potential ethnic and religious discord are also key for China.

Advancing economic cooperation and integration will not be easy, given the multilayered complexity of the process. The EEU is a good example: although the treaty has been signed, various details, particularly those related to free capital and labor mobility and equal educational opportunity, still need to be agreed on. Bilateral agreements on “exclusions,” that is, traded goods excluded from the ECU CETs and phasing-out, remain unclear and unpredictable. Another concern is the lack of clarity on the extent of harmonization, or on a timetable for steps in other policy areas (tax policy, financial regulation). Free labor mobility will be hard to achieve in the short term because of significant income gaps among CCA countries and restrictive migration policies. On CAREC, further tangible progress hinges on developing stronger country ownership and mainstreaming CAREC into the national development agenda.

Policy Implications

CCA countries should move toward liberalizing their restrictive trade regimes on a multilateral basis within the WTO framework. Accession to the WTO by more CCA countries would provide a common framework for formal trade policies, as well as access to a powerful multilateral dispute resolution mechanism. WTO accession could bring further benefits by encouraging liberal policies and punishing backsliding on commitments.

Regional integration initiatives should be complemented with structural reforms to promote openness, with due consideration given to potential vulnerabilities associated with increased external openness. Experience in other regions suggests that successful economic integration hinges on ambitious and decisive complementary structural reforms, including establishing proper governance mechanisms and institutions. More forceful market-enabling and market-deepening reforms are necessary to underpin further promotion of openness by mitigating such key constraints as corruption, inadequate labor skills, and poor infrastructure. Structural reforms should be complemented by encouraging strong political commitments and grassroots efforts at integration, involving individuals, private sector firms, nongovernmental organizations, and other stakeholders. Strengthening and modernizing macroeconomic frameworks and prudential regimes in tandem with increased openness and integration is also important, especially because the CCA countries have common vulnerability to external shocks owing to their limited diversification and links with the same regional trading partners. Greater integration among similar countries can exacerbate shocks, and sudden changes in the direction of capital flows may induce boom-bust cycles, especially in countries with less developed financial sectors. Gradual and flexible implementation of integration initiatives can help mitigate these risks.

Statistical Appendix

This publication features an abbreviated version of the Statistical Appendix. The full Statistical Appendix is available online at www.imf.org/external/pubs/ft/reo/2014/mcd/eng/pdf/mreost1014.xlsx.

The IMF’s Middle East and Central Asia Department (MCD) countries and territories comprise Afghanistan, Algeria, Armenia, Azerbaijan, Bahrain, Djibouti, Egypt, Georgia, Iran, Iraq, Jordan, Kazakhstan, Kuwait, the Kyrgyz Republic, Lebanon, Libya, Mauritania, Morocco, Oman, Pakistan, Qatar, Saudi Arabia, Somalia, Sudan, Syria, Tajikistan, Tunisia, Turkmenistan, the United Arab Emirates, Uzbekistan, the West Bank and Gaza, and Yemen.

The following statistical appendix tables contain data for 31 MCD countries. Data revisions reflect changes in methodology and/or revisions provided by country authorities.

All data for Syria are excluded for 2011 onward due to the uncertain political situation.

2011 data for Sudan exclude South Sudan after July 9; data for 2012 onward pertain to the current Sudan.

All data refer to the calendar years, except for the following countries, which refer to the fiscal years: Afghanistan (March 21/March 20 until 2011, and December 21/December 20 thereafter), Iran (March 21/March 20), Qatar (April/March), and Egypt and Pakistan (July/June) except inflation.

Data on consumer price inflation in Table 1 relate to the calendar year for all aggregates and countries, except for Iran, for which the Iranian calendar year (beginning on March 21) is used.

Tables 1, 3, 4, 6, 7, 8, and 9 include data for West Bank and Gaza.

In Table 1, “oil GDP” includes “gas GDP.” In Table 5, “oil” includes gas, which is also an important resource in several countries.

REO aggregates are constructed using a variety of weights as appropriate to the series:

  • Composites for data relating to the domestic economy (Table 1, Table 2: Oil and Non-Oil Real GDP Growth, and Tables 35) and monetary sector (Table 8: Credit to Private Sector), whether growth rates or ratios, are weighted by GDP valued at purchasing power parities as a share of total MCD or group GDP. Country group composites for the growth rates of broad money (Table 8: Broad Money Growth) are weighted by GDP converted to U.S. dollars at market exchange rates (both GDP and exchange rates are averaged over the preceding three years) as a share of MCD or group GDP.

  • Composites relating to the external economy (Tables 6 and 7) denominated in U.S. dollars are sums of individual country data after conversion to U.S. dollars at the average market exchange rates in the years indicated for balance of payments data and at end-of-year market exchange rates for debt denominated in U.S. dollars. Composites relating to the external economy (Tables 6 and 7) denominated in percent of GDP/months of imports are sums of individual country data divided by sums of dollar denominated GDP/sums of imports denominated in US dollars.

  • Composites in Table 2 (Crude Oil Production) are sums of the individual country data.

Table 1.

Real GDP Growth and Consumer Price Inflation

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Sources: National authorities; and IMF staff estimates and projections.

Data on a calendar year basis for all countries, except Iran.

Iran’s real GDP growth for 2012 and beyond has not been significantly updated from previous REO in light of pending publication of national accounts by the central bank and new authorities’ plans.

West Bank and Gaza is not a member of the IMF and is not included in any of the aggregates.

Table 2.

Oil Exporters: Oil and Non-Oil Real GDP Growth; and Crude Oil and Natural Gas Production

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Sources: National authorities; and IMF staff estimates and projections.

Including condensates.