Highlights
Economic activity in the Middle East and Central Asia (MCD) region continued to be strong in 2007, underpinned by robust global growth, high commodity prices, and improved policy frameworks. Real GDP grew at about 6½ percent, matching the region’s performance in 2006, and marking its best five-year performance since the 1980s. In oil-producing countries, relatively flat oil production limited the direct contribution of the oil sector to growth, but the record-high oil prices continued to support vigorous non-oil economic activity by financing large public investment programs and generous wage settlements and by boosting business and consumer confidence. Despite higher fuel import costs, emerging market and low-income countries in the region have benefited indirectly from the surge in oil prices through increasing foreign direct investment (FDI), particularly from the Gulf Cooperation Council (GCC)1 countries and worker remittances.
Growth was, however, accompanied by a pickup in inflation, reflecting rising international food and fuel prices, booming domestic demand, and increasingly binding capacity constraints, particularly in the housing sector. Strong domestic demand was driven by expansionary macroeconomic policies and a sharp increase in private investment, buoyed by optimism about the region’s medium-term growth prospects. Notwithstanding the fiscal and monetary expansion and strong import growth, the further rise in oil revenues generated fiscal and current account surpluses for the region as a whole of 5 and 15 percent of GDP, respectively, strengthening public sector balance sheets and reducing external vulnerability. International reserves approached the US$1 trillion mark, while external debt fell below 30 percent of GDP. Most equity markets in the region rebounded following the correction in 2006.
All countries in the region have been largely unscathed by the recent financial turmoil in developed countries, except Kazakhstan, where the banking sector relied heavily on foreign borrowing. As in most other emerging markets and developing countries, this resilience owes much to the region’s strengthened macroeconomic position and progress with structural reforms.
The short-term outlook for the MCD region remains favorable, given the expectation that commodity prices will remain high, notwithstanding the downward revision in global growth. The surge in investment and strong productivity gains from broad-based structural reforms are expected to sustain growth at around 6 percent. However, against the background of persistently high fuel and food prices, strong domestic demand, and supply bottlenecks, inflationary pressures are unlikely to abate. With high oil prices boosting oil revenues, fiscal and current account surpluses in oil-producing countries are projected to remain large despite stronger imports and further fiscal expansion. In most non-oil-producing countries, the policy stance will likely aim to rein in fiscal and external deficits, contributing to further accumulation of international reserves and helping to reduce vulnerabilities.
Risks to the outlook are broadly neutral, with upside risks from domestic demand likely to be balanced by downside risks from the external sector. High oil prices and further cuts in U.S. interest rates could lead to a stronger-than-expected increase in domestic demand in the GCC countries.
Furthermore, the growing surplus in oil exporters, combined with concerns about asset quality in advanced economies, may well lead to increased inflows to the other countries in the region, fueling stronger credit and domestic demand. However, a protracted slowdown in advanced economies would hurt growth in most MCD countries, depressing exports and commodity prices. Tighter credit in advanced economies and lower risk appetite, as evidenced by widening sovereign spreads, could also curtail the capital inflows that have supported growth in many countries in the region.
The key macroeconomic policy challenge in the short run for most countries in the region is to contain rising inflationary pressures, and for countries with large external debts and current account deficits to protect their external stability in the context of high oil prices and slowing world growth. The appropriate policy mix will depend on each country’s particular circumstances but would most likely call for fiscal and monetary tightening and greater exchange rate flexibility when feasible. In oil-exporting countries with currencies pegged to the U.S. dollar, demand management policies will face challenges in controlling inflation, given the continuing bias toward monetary easing in the United States. The burden of the adjustment may well have to fall on fiscal policy, particularly in the GCC countries where a change in the exchange rate regime would be disruptive in the run-up to the planned monetary union. But the room for maneuver of fiscal policy is also limited in view of the need for higher investment to alleviate supply bottlenecks and political pressure for higher spending on wages and social programs. Therefore, tolerating somewhat higher inflation for a while may be necessary.
Beyond this immediate challenge, policies need to remain focused on strengthening policy frameworks, promoting sound financial deepening, and supporting the growth potential of the private sector.
In particular, countries need to continue strengthening their fiscal policy frameworks tailored to address specific issues in their fiscal outlook, most notably the efficient and sustainable use of oil revenues in oil-exporting countries, and high public debt in some low-income and emerging market economies. Phasing out fuel and food subsidies while establishing a more targeted safety net would help some countries in the region preserve long-term fiscal sustainability, enhance efficiency of spending, and improve equity. For countries where greater exchange rate flexibility is desirable over the medium term, it is important to continue to lay the foundation of an independent monetary policy. Despite the difficult challenges ahead, GCC countries should be encouraged to keep the agenda of the proposed monetary union on track, including reaching consensus on the appropriate exchange rate regime.
Continued development of banking systems will be critical for achieving high growth and for the region’s successful integration into the world economy. In particular, dealing with the large stock of nonperforming loans and restructuring state banks in some countries will be crucial for enhancing the efficiency of the banking sector and lowering the cost of borrowing. Strong supervisory vigilance is also important, particularly in countries experiencing rapid credit growth.
The private sector is essential for the expansion and diversification of the production and export base of MCD economies and for the creation of jobs for the rapidly growing labor force—a pressing problem for many countries in the region. Among the key policies in this regard are those to improve the investment climate and lower the cost of doing business (including by reducing barriers to trade and removing excessive government controls and regulations), to enhance the transparency of the legal and administrative systems, and to overhaul national education systems to meet the demands of an increasingly competitive world economy.
The May 2008 Regional Economic Outlook: Middle East and Central Asia(REO), covering countries in the Middle East and Central Asia Department (MCD) of the International Monetary Fund (IMF), provides a broad overview of recent economic developments in 2007 and prospects and policy issues for 2008. To facilitate the analysis, the 30 MCD countries covered in this report are divided into three groups: oil exporters, low-income countries, and emerging market countries.2 Countries are grouped based on the share of oil in total exports, per capita income, and access to international capital markets. The following geographical groupings are also used: the Caucasus and Central Asia (CCA), Middle East and North Africa (MENA), Gulf Cooperation Council (GCC), and Maghreb.
Recent Economic Developments
The MCD region grew at a rapid pace in 2007, benefiting from the boom in oil and other commodity prices, the strong global economy, and improved policy frameworks. Regional growth exceeded 6 percent for the fifth consecutive year, a marked improvement from the low and volatile growth in the previous five years. Although significant, this growth acceleration was still below the average performance in other developing countries and well behind that of dynamic emerging market countries (Figure 1). The turmoil in the international financial markets since mid-summer had little impact on countries in the region, except for Kazakhstan, which experienced difficulties owing to banks’ heavy reliance on foreign borrowing.
Global Real GDP Growth
(Annual change; in percent)
Sources: Data provided by country authorities; and IMF staff estimates and projections.Among MCD countries, growth remained at about the same level as in 2006 in oil-exporting countries, strengthened in low-income countries, and was mixed in emerging market economies (Figure 2):
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In oil-exporting countries, with oil production increasing modestly to 28.4 million barrels a day (mbd) in 2007 from 27.9 mbd in 2006, the direct contribution of the oil sector to growth was very small, with value added growing at a mere 2¼ percent. The indirect contribution to growth of the boom in oil prices was, however, substantial; it helped to sustain a fast-paced expansion of non-oil economic activity by financing large public investment programs and generous wage settlements and by boosting business confidence. All in all, non-oil GDP grew by 7¼ percent in 2007, contributing to overall growth of 6¼ percent (Figure 3).
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Low-income countries recorded 8¾ percent growth. Double-digit growth was registered in Armenia, supported by strong domestic demand; Georgia, where the ambitious reform program initiated in 2004 led to a remarkable economic rebound (Box 1); and Sudan, driven by a large increase in oil production, although non-oil GDP growth has moderated somewhat. In Afghanistan, growth doubled to 12½ percent, owing to a strong rebound in agricultural production. In Mauritania, oil production, which had come on stream in 2006 and boosted growth to double-digit levels, plummeted in 2007 as a result of technical difficulties in the oil sector and brought overall growth close to zero. Nonetheless, growth of the non-oil sector, which is the main driver of employment and household disposable income, accelerated to about 6 percent.
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Average growth in emerging market countries moderated to 6 percent from 6½ percent in 2006 (Figure 4), mainly reflecting the sharp deceleration of growth in Morocco, resulting from a weather-related 20 percent contraction in its agricultural output. Lebanon saw a recovery from the 2006 conflict-related trough, despite the prolonged political stalemate over the presidential election. The other economies enjoyed a year of robust and well-balanced growth, supported in part by a strong pickup in foreign direct investment (FDI) from the GCC countries (Box 2). In Egypt, growth accelerated, broadening to labor-intensive sectors and contributing to a marked decline in unemployment. In the other countries, higher growth over the past few years failed to make a significant dent in unemployment, which remains one of the main challenges facing policymakers in the MCD region.
Real GDP Growth in the MCD Region
(Annual change; in percent)
Sources: Data provided by country authorities; and IMF staff estimates and projections.Oil and Non-Oil GDP Growth in Oil Exporters, 2007
(Annual change; in percent)
Sources: Data provided by country authorities; and IMF staff estimates.Georgia: Successful Reforms Since the Rose Revolution
Georgia has shown impressive growth rates due to a rigorous reform of the business environment. The growth momentum was resilient enough to weather the loss of the Russian export market, and also appears to remain strong despite political uncertainties since the opposition protests in November 2007.
When the Shevardnadze government was forced out of office by opposition protests over irregularities in the 2003 election (the “Rose Revolution”), the economy was still suffering from the fall in GDP during the 1990s—almost 75 percent, by most estimates the worst for any transition country. Mismanagement had undermined Georgia’s institutions, including tax and customs administration.
The new government under President Saakashvili, one of the leaders of the protests, embarked on an ambitious reform agenda, which resulted in a remarkable economic turnaround (growth went up from an average of 5.8 percent in 2000–03 to 9.3 percent in 2004–07), which exceeded the average non-oil-producing CCA growth rate (Figure B1.1). This growth was also broad based.
Economic reforms, some of which were supported by IMF programs, focused on the following areas:
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The government’s stake in the economy was reduced through an ambitious privatization program. Restrictions on foreign investment, in particular in the banking sector, were removed.
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The tax system was simplified by reducing the number of tax brackets from 21 to 7 and curtailing exemptions and special regimes.
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The customs regime was radically liberalized, with 90 percent of all goods now free of customs duties.
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Burdensome red tape was abolished.
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Tax and customs administration improved. The tax department was reorganized, a financial police force was established, and corrupt high-ranking officials were prosecuted.
These reforms radically improved conditions for doing business. In the World Bank’s “Doing Business” survey, Georgia has moved up by 95 positions since 2004, reaching position 18 in the 2008 survey, above Belgium and Germany. Popular reforms, such as the reform of the corrupt traffic police, gained the government broad-based support and strengthened political stability.
In the favorable global economic climate, these reforms attracted capital inflows, mainly in the form of FDI. The largest foreign-financed investment project was the construction of the strategically important oil pipeline that connects the Caspian Sea to the Mediterranean. But there was also a broad range of smaller projects, from real estate to the banking sector, where foreign investment supported a credit boom.
Real GDP Growth
(Annual change; in percent)
Sources: Data provided by country authorities; and IMF staff calculations.1 Simple average, excludes Georgia.2 Simple average, excludes Georgia and oil-exporting countries (i.e., Azerbaijan, Kazakhstan, and Turkmenistan).While fiscal developments were generally positive, the large capital inflows created a challenging environment for monetary policy. Because of tax policy and administration reforms, tax revenues were buoyant, allowing room for a substantial increase in expenditures, particularly to upgrade infrastructure (Figure B1.2). But, with government spending rising fast, monetary policy was left with the difficult task of keeping inflation under control during a period of increasing capital inflows. In fact, reflecting concerns about competitiveness, the central bank intervened heavily in the foreign exchange market to limit exchange rate appreciation and sterilized only a small fraction of the injected liquidity, contributing to strong inflationary pressures (Figure B1.3).
Georgia’s newly reformed economy faced a major challenge when relations with Russia deteriorated in the fall of 2006, resulting in the closure of the border and, consequently, a sharp decline in exports. In addition, Russia drastically increased the price of natural gas imports, a major heating source in Georgia. The deterioration of the current account in late 2006 due to weaker exports to Russia was limited owing to the success of Georgian exporters in finding new markets. Reducing the dependence on Russian gas by diversifying imports, in particular from Azerbaijan, remains the government’s priority.
Another challenge for the government came when opposition rallies clashed with the police in November 2007, creating an environment of political uncertainty. In an effort to restore confidence, President Saakashvili resigned and called an early presidential election. He was reelected in January 2008 in an election that was considered fair by international observers. While capital inflows paused after the November events, they recovered quickly and are expected to reach a record high in 2008.
Although impressive progress has been achieved in advancing economic reforms and improving the business climate, important challenges remain. The government has already announced a stronger emphasis on social issues to address still-widespread unemployment and poverty. Oversight of the banking system needs to be strengthened, and the central bank is preparing a framework for moving toward its medium-term goal of inflation targeting. For the near term, the government has prepared a macroeconomic package that aims to bring down inflation while preserving strong growth.
Tax-to-GDP Ratio
(In percent)
Sources: Data provided by country authorities; and IMF staff calculations.1 Simple average, excludes Georgia.Inflation
(In percent)
Sources: Data provided by country authorities; and IMF staff calculations.1 Simple average, excludes Georgia.GCC Capital Flows to MENA Emerging Market Countries
High oil prices have also benefited non-oil-exporting countries in the MENA region because oil exporters, particularly the GCC countries, are directing an increasing share of their foreign investments to the region. The majority of the flows are FDI, often linked to privatizations, but large infrastructure and new equity investments are also on the rise.
The accumulation of financial wealth and the search for higher yields have led GCC investors to diversify their investment strategy, geographically and across asset classes. As a result, an increased share of GCC funds is flowing to other emerging market economies. While hard data are scarce, there are indications that this trend has benefited many countries in the MENA region. According to a recent estimate by the Institute for International Finance, GCC investment into the broader MENA region during 2002–06 could account for about US$60 billion, or 11 percent of estimated total GCC capital outflows during the period, and about one-fifth of the amount GCC countries invested in the United States.
FDI constitutes the bulk of GCC investment in Algeria, Egypt, Jordan, Morocco, and Tunisia. While the FDI inflows from GCC countries have significantly increased during the past few years, their level remains relatively modest so far (Table B2.1).
Investment flows have tended to be rather irregular, reflecting the preponderance of privatization operations, principally in the telecommunications (Egypt and Tunisia) and financial sectors (Tunisia). Recently announced large investment projects, mostly in the real estate and tourism sectors, could dramatically alter this assessment. In Morocco, about US$6 billion in GCC-sourced investment was approved between January and April 2007, more than double the amount during the same period in 2006. In Tunisia, GCC-based companies recently committed about US$29 billion over a 10- to 20-year horizon in five separate real estate development projects. There are indications that new equity investments are also on the rise in Egypt and Jordan.
In addition to FDI, the broader MENA region has also benefited from foreigners purchasing equity in private companies listed on stock exchanges. Although portfolio flows are increasing in several countries, they remain relatively modest and their sources are not easily amenable to geographical classification. As a result, the role played by increased capital flows from the GCC in the performance of the region’s stock markets—particularly the Amman, Cairo, and Casablanca stock exchanges—in the last couple of years is difficult to ascertain. Foreign investors account for about one-third of market capitalization in Egypt and Morocco, and close to half the shares on the Amman stock exchange. Arab investors are estimated to account for one-half of total foreign holdings in Egypt and three-fourths in Jordan.
A sustained increase of capital inflows to the region’s emerging markets could bring substantial macroeconomic and financial benefits, but also raise significant challenges for the design and conduct of economic policy. Recent experience in emerging market countries with large capital inflows underscores the need for appropriate coordination of monetary and fiscal policies, financial market deepening, and vigilant supervision as key instruments for mitigating these risks.
FDI in Egypt, Morocco, and Tunisia
(In billions of U.S. dollars)
FDI in Egypt, Morocco, and Tunisia
(In billions of U.S. dollars)
| 2005 | 2006 | 2007 | ||
| Egypt | ||||
| FDI Inflows | 3.9 | 6.1 | 11.1 | |
| As a percent of GDP | 4.3 | 5.7 | 8.6 | |
| Share from GCC-6 | 4.6 | 3.4 | 25.2 | |
| Morocco 1 | ||||
| FDI Inflows | 2.9 | 2.9 | 2.8 | |
| As a percent of GDP | 5.0 | 4.4 | 3.8 | |
| Share from GCC-6 | 5.0 | 8.3 | 14.8 | |
| Tunisia | ||||
| FDI Inflows | 0.8 | 3.3 | 1.6 | |
| As a percent of GDP | 2.7 | 10.7 | 4.6 | |
| Share from GCC-6 | 9.7 | 69.4 | 3.8 | |
FDI in Egypt, Morocco, and Tunisia
(In billions of U.S. dollars)
| 2005 | 2006 | 2007 | ||
| Egypt | ||||
| FDI Inflows | 3.9 | 6.1 | 11.1 | |
| As a percent of GDP | 4.3 | 5.7 | 8.6 | |
| Share from GCC-6 | 4.6 | 3.4 | 25.2 | |
| Morocco 1 | ||||
| FDI Inflows | 2.9 | 2.9 | 2.8 | |
| As a percent of GDP | 5.0 | 4.4 | 3.8 | |
| Share from GCC-6 | 5.0 | 8.3 | 14.8 | |
| Tunisia | ||||
| FDI Inflows | 0.8 | 3.3 | 1.6 | |
| As a percent of GDP | 2.7 | 10.7 | 4.6 | |
| Share from GCC-6 | 9.7 | 69.4 | 3.8 | |
Growth in Emerging Markets
(Annual change; in percent)
Sources: Data provided by country authorities; and IMF staff estimates.By geographical region, growth remained the highest in the CCA3 (12 percent), boosted by strong exports and remittances, increased FDI inflows, and record-high oil and commodity prices, as well as by expansionary fiscal and monetary policies. In Azerbaijan, growth exceeded 20 percent for the third consecutive year, driven by a large increase in oil production, which now accounts for 60 percent of GDP. In the GCC countries, high oil prices and a liberal economic environment helped boost public and private investments alike, creating a significant growth momentum (non-oil GDP grew by 7¾ percent, with Kuwait, Oman, Qatar, and the United Arab Emirates (U.A.E.) growing at nearly 10 percent). The severe drought in Morocco and the disruption of oil production in Mauritania weighed down average growth in Maghreb4 countries. A decline in violence, good macroeconomic management, and progress on structural reforms have put the Iraqi economy on a path toward macroeconomic stability and higher growth (Box 3).
Inflation, which has generally increased across all countries in the world, has also been on the rise in most MCD countries, particularly in oil-producing countries (Figures 5a and 5b). This reflects the increase in oil and food prices;5 the depreciation of the U.S. dollar, to which many MCD currencies are pegged; buoyant domestic demand; and supply bottlenecks, particularly in the housing sector.
Iraq: Encouraging Economic Performance in 2007
The Iraqi economy showed encouraging signs of improvement in 2007. Much remains to be done, however, to consolidate macroeconomic stability and increase economic growth. The economic outlook for 2008 and beyond depends critically on further security improvements and higher investment.
The past five years have been extremely difficult for the Iraqi economy, but during the course of 2007 some encouraging signs of improvement began to emerge. The level of violence came down sharply (Figure B3.1), and this was accompanied by a number of successes on the economic front.
Particularly impressive was the decline in inflation achieved during 2007. Inflation accelerated during 2006, partly reflecting fuel shortages, and ended the year at 65 percent—double the inflation rate at the end-2005 (Figure B3.2). The authorities responded with a policy package including exchange rate appreciation, monetary tightening, and fiscal discipline. These policies, together with measures to reduce fuel shortages, brought inflation down to less than 5 percent by December 2007. Core inflation—which excludes fuel and transportation prices—fell to about 12 percent in 2007, from 32 percent in 2006.
The Iraqi authorities also made considerable progress in addressing distortionary and wasteful fuel price subsidies. Fuel price adjustments—which had started in 2005 from a very low price (about 1 U.S. cent per liter of gasoline)—continued in 2007, bringing domestic fuel prices in line with (and sometimes above) regional levels (Figure B3.3). The benefits of this bold move were substantial. Direct fuel subsidies, which amounted to no less than 13 percent of GDP in 2004, were eliminated, except for a small subsidy on kerosene, and incentives to smuggle fuel out of the country were significantly reduced. This allowed the authorities to expand the resource envelope available to address Iraq’s reconstruction and social needs.
Violence Indicators, June 2003–December 2007
(Casualties and oil sector attacks per month)
Sources: Iraq Pipeline Watch; and Iraq Body Count.Consumer Price Inflation, August 2004–December 2007
(Annual change; in percent)
Sources: Data provided by country authorities; and IMF staff calculations.Crude oil production and exports, which had stagnated during 2005 and 2006, rose during the second half of 2007. With better security, the flow of oil, including through the northern pipeline to Turkey, has increased in recent months. Production is reported to have reached 2.3 mbd and exports 1.8 mbd in the final quarter of 2007, compared to an average of 2.0 and 1.4, respectively, during 2006. Higher world oil prices meanwhile helped bring about a further accumulation of resources in the Development Fund for Iraq (DFI), through which all oil export revenues are channeled, to US$12.6 billion at end-2007, compared with US$8.6 billion at end-2006. Reconstruction spending, which is financed from the DFI, has picked up compared with previous years, especially in governorates, supporting economic activity across the country.
Iraq has also continued to make progress toward reducing its external debt burden. Following a three-stage agreement with the Paris Club in 2004 on the write-off of 80 percent of its debt in net present value terms, bilateral agreements have been signed with all Paris Club creditors. Some progress has also been made with non–Paris Club creditors; Iraq has signed agreements with 11 creditor countries. The sustainability of Iraq’s external debt, however, still requires the third and final tranche of the Paris Club debt relief expected at end-2008 (contingent on continued good performance under the Stand-By Arrangement with the IMF) and further progress in reaching debt reduction agreements with Iraq’s non–Paris Club creditors.
Despite the achievements in 2007, much remains to be done to consolidate macroeconomic stability and put the economy on a higher growth path. Public confidence remains very low and violence is still widespread. Corruption and governance problems continue to impede the functioning of the public and private sectors.
Iraq’s economic outlook for 2008 and beyond hinges crucially on further improvements in security. Public investment in the oil sector and in reconstruction and public service projects (in infrastructure and electricity, water and sanitation, and social sectors) are necessary to increase oil production and enable a recovery of non-oil activity. Building on the progress achieved in 2007, the Iraqi authorities are committed to advancing their reform agenda to bring the economy closer to its potential.
Consumer Price Inflation: Country Aggregates
(Year average; in percent)
Sources: Data provided by country authorities; and IMF staff estimates.Consumer Price Inflation: Individual Countries
(Year average; in percent)
Sources: Data provided by country authorities; and IMF staff estimates.In Qatar and the U.A.E., the large inflow of expatriate workers and the growing propensity of local residents to upgrade housing facilities have led to a steep rise in rents, adding significantly to inflation (Box 4). At the end of 2007, inflation was running at about 20 percent in Azerbaijan, Iran, Kazakhstan, and Tajikistan. Even in Saudi Arabia, a traditionally lowinflation country, inflation reached 6½ percent by the end of the year. Maghreb countries generally managed to control inflation in 2007, although inflationary pressures are building up. In Morocco and Tunisia, appropriately tight macroeconomic policies and increased subsidies on food (and on fuel in Morocco) kept inflation in check.
Real exchange rates remained fairly stable in oil-exporting and emerging market countries, but continued to appreciate in low-income countries. In oil-exporting countries, the pickup in inflation offset the dollar-peg-driven nominal depreciation, leaving real exchange rates broadly unchanged (Figures 6 and 7). The weakening of the dollar played a role in the decisions of Kuwait and Syria6 to abandon their peg to the U.S. currency over concerns that the depreciating dollar was fueling domestic inflation. Most emerging markets avoided further real appreciation by controlling inflation and allowing their currencies to depreciate slightly in nominal terms. In low-income countries, persistent high inflation combined with fairly stable nominal exchange rates led to further real appreciation. Their larger current account deficits were fully financed by buoyant capital inflows.
The Rise in Inflation in the GCC Countries
Rising inflation is a growing concern among all GCC countries. Contributing factors include rising demand from large investment projects, a fast-growing population fueled by an influx of expatriates, supply-side bottlenecks, and rising costs of imported food, raw materials, and capital equipment.
The recent economic performance of the GCC countries has been impressive. Over the past five years, the GCC countries grew at an annual rate of about 7 percent, owing to record-high oil prices and a rapidly growing non-oil sector (Figure B4.1). However, the expansion has been accompanied by a general increase in consumer prices. Headline inflation averaged about 6 percent in 2007, with core inflation tracking closely behind at 5 percent.
Both domestic and external factors have contributed to the rising inflation. On the domestic front, aggregate demand has been growing rapidly. Gross capital formation, including public and private investment, increased from about 35 percent of non-oil GDP in 2003 to about 48 percent in 2007. Since 2003, government current spending has risen cumulatively by 58 percent, mainly reflecting increases in wages and subsidies. The private sector has contributed significantly to the spending boom, supported by inflows of FDI and increasing external and domestic debt (Figure B4.2). In particular, domestic credit has expanded rapidly, growing at about 30 percent a year since 2004, and reaching an estimated 56 percent of GDP in 2007.
Supply constraints have contributed significantly to inflationary pressures in a number of nontradable sectors, especially construction. Specifically, shortages of residential and commercial housing units have led to higher rents. In Qatar and the U.A.E., which have the highest inflation rates in the GCC countries, and more recently in Kuwait and Oman, rising housing costs have been the main driver of inflation (Figure B4.3). In Qatar and the U.A.E., the housing markets have been further strained by a rapidly growing population—spurred by a large inflow of expatriates—and the opening up of real estate markets to foreign buyers.
Growth and Inflation in the GCC
Sources: Data provided by country authorities; and IMF staff calculations.GCC: Growth of Broad Money and Credit to the Private Sector
Sources: Data provided by country authorities; and IMF staff calculations.Consumer price inflation has also been affected by external factors. Rising international prices of food, capital equipment, and raw materials have added to inflationary pressures in goods and services with a large import content. The depreciation of the U.S. dollar—to which GCC countries’ currencies, except that of Kuwait, are pegged—vis-à-vis other major currencies has also contributed to inflationary pressures, but to a lesser extent. In fact, the GCC countries’ average nominal effective exchange rate (NEER) was relatively flat during 2004–06, but inflation in the region was rising (Figure B4.4). In the high-inflation countries, such as Qatar and the U.A.E., inflation rose much faster than the rate of depreciation of the NEER.
Over the medium term, substantial domestic investments will continue to drive economic growth. Aggregate demand is expected to remain strong, fueled by high oil prices and robust growth in the non-oil sector. At the same time, supply constraints are expected to ease, especially if more rental units come on the market. While inflation is projected to increase slightly to about 7 percent on average in 2008, it is expected to gradually decrease over the medium term.
Contribution to CPI Inflation in the GCC
(In percent)
Sources: Data provided by country authorities; and IMF staff estimates.GCC: Exchange Rates and Inflation
(Index, 2000 = 100)
Sources: Data provided by country authorities; and IMF staff calculations.Nominal Effective Exchange Rates
(Index, 2000 = 100; increase indicates appreciation)
Source: IMF Information Notice System.Real Effective Exchange Rates
(Index, 2000 = 100; increase indicates appreciation)
Source: IMF Information Notice System.Fiscal savings declined in 2007, led by a fall in the surplus of oil exporters. Nonetheless, the region registered an overall budget surplus of 5½ percent of GDP, allowing a strengthening of public balance sheets and a reduction in external vulnerabilities as international reserves increased and reliance on external borrowing declined (Figures 8a, 8b, and 9).
Government Fiscal Balance: Country Aggregates
(In percent of GDP)
Sources: Data provided by country authorities; and IMF staff estimates and projections.Government Fiscal Balance: Individual Countries
(In percent of GDP)
Sources: Data provided by country authorities; and IMF staff estimates.Total Government Debt
(In percent of GDP)
Sources: Data provided by country authorities; and IMF staff estimates and projections.-
With the exception of Azerbaijan, Kazakhstan, and Libya, where the oil-boom-financed fiscal expansion is in full swing, the fiscal expansion in the other oil exporters moderated, with non-oil fiscal deficits leveling off or declining (Figure 10). In Syria, further cuts in capital spending allowed a timely adjustment to the precipitous decline in oil revenues. For the group of oil exporters, the average saving rate of fiscal oil revenues—the ratio of the overall fiscal balance to fiscal oil receipts—is estimated to have declined from 46 percent in 2005–06 to 43 percent in 2007. Oil exporters are spending a substantial share of the increase in oil revenue on infrastructure and social programs and on measures aimed at diversifying the economy (Box 5).
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In low-income countries, fiscal performance has been generally satisfactory. In Djibouti, fiscal policy has been supportive of the economy’s revival. Fiscal consolidation in the Kyrgyz Republic has resulted in a declining debt-to-GDP ratio. In Mauritania, the fiscal position strengthened further, benefiting from the modernization of tax administration and computerization of budget execution. However, in Sudan, problems in public finance management led to the further accumulation of domestic arrears, while in Georgia, a marked loosening of fiscal policy contributed to large current account deficits and inflationary pressures.
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In most emerging market economies, fiscal policies were aimed at further fiscal consolidation in the context of dynamic private sector activities. Buoyant tax revenues and wage restraint offset an increase in subsidies (to mitigate the effect of rising fuel and food prices). This kept the fiscal deficits broadly unchanged, which, combined with privatization receipts, allowed some progress toward lowering debt-to-GDP ratios.
Government Expenditure in Oil Exporters
(Nominal; annual change; in percent)
Sources: Data provided by country authorities; and IMF staff estimates.The course of monetary policy across the region has been largely shaped by existing exchange rate regimes.
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In oil-producing countries with currencies de jure or de facto pegged to the U.S. dollar, the widening discrepancy between their business cycle and that of the U.S. economy has created challenges for monetary management and mounting pressures for a revaluation. Central banks had to lower interest rates in line with the monetary easing in the United States. Real interest rates became increasingly negative, spurring rapid credit growth and adding demand pressures to already overheated economies (Figure 11).
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In countries that enjoy greater monetary independence, monetary policies have generally been geared toward reining in inflation. Egypt allowed some appreciation of its currency and raised policy interest rates to contain money and credit expansion. Tunisia sought to slow credit growth by raising the reserve requirement in the context of higher prices of oil and basic commodities and a further depreciation of its currency. In the context of moderating inflation and a slowing economy, Morocco eased monetary policy toward the end of the year. In Kazakhstan, despite some measures taken in 2006 and early 2007 to tighten monetary policy, credit continued to grow at rates close to 100 percent. When the credit squeeze hit in September, the authorities changed course, injecting liquidity through a number of channels. Once the situation had stabilized, and in the context of soaring inflation, the National Bank of Kazakhstan shifted its stance slightly, raising the policy interest rate from 9 percent to 11 percent in November.
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In countries with shallow banking sectors, the process of remonetization and financial deepening continued, although the rapid expansion of credit has raised not only inflationary risks but also risks to the quality of banks’ portfolios (Figures 11 and 12). In Armenia, broad money—and in particular dram broad money—has been growing rapidly, reflecting dedollarization and remonetization, increased confidence in the banking system, and an appreciating currency. Driven by mortgage and consumer loans, private sector credit growth accelerated significantly, exceeding 75 percent by year-end.
Credit to the Private Sector
(Annual change; in percent)
Sources: Data provided by country authorities; and IMF staff estimates.Money and Credit to the Private Sector in Low-Income Countries
(In percent of GDP)
Sources: Data provided by country authorities; and IMF staff estimates.Algeria’s Experience with Managing Hydrocarbon Wealth
Sound management of hydrocarbon wealth has helped Algeria achieve macroeconomic stability, with very comfortable fiscal and external positions. Deeper structural reforms, especially in financial intermediation, are needed to diversify the economy and further reduce unemployment.
Algeria is the world’s third-largest exporter of natural gas and the world’s tenth-largest oil exporter. The authorities have been committed to the sound management of associated hydrocarbon revenues through prudent macroeconomic policies, a liberal trade regime, and structural reforms aimed at economic diversification. Efforts are starting to bear fruit, but more needs to be done to reduce the economy’s dependence on hydrocarbons (almost all its exports) and to create jobs for the young labor force.
Annual GDP growth has averaged about 5 percent since 2002, reflecting both higher hydrocarbon growth and strong activity in the nonhydrocarbon sector (Figure B5.1). Inflation remained subdued and unemployment declined steadily to 12 percent in 2006, although it is double that among the youth. Hydrocarbon export receipts have considerably strengthened both the fiscal and external positions (Figure B5.2). The external current account surplus increased to 23 percent of GDP in 2007 from about 8 percent in 2002, despite the doubling of imports over this period. The overall fiscal surplus rose to almost 12 percent of GDP in 2007 from zero in 2002.
Market-based policies have increasingly aimed at diversifying the economy and promoting a dynamic private sector. Trade liberalization included tariff reform (2001), the Association Agreement with the European Union (2005), and progress toward accession to the World Trade Organization. The authorities have also pursued financial sector reforms, with progress in banking supervision, the operating environment for financial intermediation, public banks’ governance, entry of foreign banks, and the development of the local corporate bond market.
Hydrocarbon wealth has allowed the government to (1) launch a massive public investment program for 2005–09 (US$155 billion or 120 percent of 2007 GDP) to improve infrastructure, housing, and the delivery of public services; (2) rationalize the tax system and cut tax rates; and (3) reduce gross public debt to 12 percent of GDP in 2007 from more than 50 percent in 2002 (Figure B5.3). Nevertheless, official reserves now exceed US$100 billion, and the authorities have saved about half of hydrocarbon budget revenues in a hydrocarbon stabilization fund (FRR) that was established in 2000.
Real Sector Developments
(Growth rates; in percent)
Sources: Data provided by country authorities; and IMF staff estimates and projections.Fiscal and External Developments
(In percent of GDP)
Sources: Data provided by country authorities; and IMF staff estimates and projections.The authorities view the FRR as a temporary stabilization fund. The FRR does not have governance arrangements that characterize sovereign wealth funds; it is a mere subaccount of the government at the central bank. The account is denominated in local currency and remunerated at the same rate of interest as the one-year Algerian treasury bill. Outflows from the FRR finance government spending in excess of nonhydrocarbon budget revenues and pay down public debt.
About one-third of hydrocarbon export receipts accrue to the oil sector and have boosted the cash reserves of Sonatrach, the national oil company. As a result, Sonatrach has announced plans to invest about US$50 billion over the next few years. Investments are mainly in exploration and development of new fields in Algeria, with the objectives of lifting output capacity in crude oil from 1.4 mbd to 2 mbd, and increasing natural gas exports from 62 billion cubic meters a year to 85 billion. Other planned investments are scheduled to develop local downstream activities and oil and natural gas assets outside Algeria. Most of Sonatrach’s investments will be made in conjunction with foreign associates, continuing the policy of opening up the hydrocarbon sector, which Algeria began in 1986.
Algeria’s economic outlook is positive. In the short term, however, the ongoing public investment program could generate inflationary pressures. In the medium term, the acceleration in nonhydrocarbon growth could prove short lived if the public investment program does not generate a lasting domestic supply response. Sustaining the recent favorable economic performance and further reducing unemployment would require (1) ensuring that the ongoing expansionary stance of fiscal policy does not threaten macroeconomic stability or the quality of government spending; and (2) deepening structural reforms, especially in the financial sector, to improve Algeria’s low productivity and sustain the growth of the nonhydrocarbon sector.
Public Debt
(In percent of GDP)
Sources: Data provided by country authorities; and IMF staff estimates and projections.Notwithstanding the further rise in oil revenue for the region, the sustained expansion of MCD imports has made a positive net contribution to global growth and helped the narrowing of global imbalances (Box 6). The overall current account surplus of the region declined to 15 percent of GDP from 16¼ percent in 2006 (Figures 13a and 13b). Reflecting greater financial integration into the world economy, gross capital flows into and out of the region have also increased at a brisk pace.
External Current Account Balance: Country Aggregates
(In percent of GDP)
Sources: Data provided by country authorities; and IMF staff estimates and projections.External Current Account Balance: Individual Countries
(In percent of GDP)
Sources: Data provided by country authorities; and IMF staff estimates.Oil Income: What Is Being Done with It?
A massive program of much-needed infrastructure upgrading and social spending is under way in MCD oil-exporting countries. With higher world oil prices boosting export incomes even further, the narrowing of the region’s external surpluses will be more modest than previously envisaged. Nevertheless, the countries’ latest budget plans imply a large increase in spending, which will provide welcome support to global economic demand.
The region’s oil and gas export receipts are likely to amount to US$940 billion in 2008, close to US$200 billion more than was envisaged late last year (Figure B6.1). For the most part, this reflects higher world oil prices, which are now projected to average over US$95 a barrel (based on prevailing futures market prices), compared with US$75 in October 2007. This represents an almost fivefold increase from the annual levels at the start of the decade. On the fiscal side, government revenue from oil and gas is now estimated at close to US$740 billion in 2008, about US$160 billion more than expected a few months ago.
Higher income is translating into rapid import growth. Reflecting the major investment programs as well as an expansion in consumer spending, the region’s share of global imports of goods and services has risen from under 2½ percent in 2001 to almost 4 percent (projected) in 2008 (Figure B6.2). A major factor underlying the acceleration of imports has been the marked pickup in fiscal spending, where the growth of budgetary expenditures has averaged almost 20 percent annually in recent years. Thus, greater fiscal spending—and the associated increase in the region’s imports—is supporting demand for goods and services from the rest of the world.
The overall financial position of the region as a whole remains very comfortable, even with the large spending increase. With external and fiscal surpluses continuing due to high oil prices, the countries’ net external assets are continuing to grow. During 2004–08, the region’s cumulative overall fiscal surplus will amount to about US$1 trillion, while the cumulative external current account surplus could be as high as US$1.4 trillion. In other words, MCD oil-exporting countries are in the enviable position of enjoying the benefits of sizable spending increases while continuing to save substantial amounts for the future.
Oil Income and Imports
(In billions of U.S. dollars)
Sources: Data provided by country authorities; and IMF staff estimates and projections.Note: Data for 2001–03 exclude Iraq.Current Account and Oil-Income Spending
Sources: Data provided by country authorities; and IMF staff estimates and projections.Note: Data for 2001–03 exclude Iraq.1 Excludes Iraq.-
For oil exporters, the value of oil exports reached almost US$700 billion in 2007 (4 percent of world exports), about 15 percent higher than in 2006, with the rise in oil prices fully offsetting the small drop in export volumes from 20.9 mbd in 2006 to 20.6 mbd in 2007. The rapid growth of imports limited the increase in the current account surplus to about US$320 billion, of which about US$150 billion was invested abroad in public and private placements and the remaining US$170 billion added to international reserves, which reached about US$726 billion (Figure 14).
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Current account positions remained broadly unchanged in most emerging market countries, except in Morocco, where a sharp increase in food imports to offset the loss of domestic crops led to a sizable drop in the current account surplus. In Pakistan, notwithstanding a significant decline in import growth, the current account deficit widened to 4.9 percent of GDP, owing mainly to significantly slower export growth. The deficit was more than covered, however, by record-high capital inflows. The increase in the current account deficit in Lebanon reflects the recovery of imports following their one-off drop during the 33-day war in 2006.
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The widening of the current account deficits in most low-income countries was driven mainly by buoyant domestic demand, which led to a sharp rise in imports. In Djibouti, this reflected mainly a boom in foreign-financed investment. In Tajikistan, it reflected large investments in power generation and roads financed by foreign borrowing. By contrast, Uzbekistan continued to generate large and growing current account surpluses, boosted by remittances and strong export growth, in the context of a restrictive trade regime.
Gross Official Reserves
(In billions of U.S. dollars)
Sources: Data provided by country authorities; and IMF staff estimates and projections.FDI inflows to MCD countries topped US$80 billion in 2007, four times the level in 2002. Egypt, Saudi Arabia (mainly in the oil sector), and the U.A.E. were the largest recipients, accounting for 55 percent of the total. Regarding the region’s FDI abroad, including intraregional FDI, Saudi Arabia and the U.A.E. accounted for 70 percent of the total US$45 billion. Net financial outflows (portfolio investments, loans, deposits, and trade credits) have tripled since 2002 to over US$140 billion. Three-fourths of the total reflects the investment abroad of oil revenues from Kuwait, Saudi Arabia, and the U.A.E. For the region as a whole, the large current account surplus and a balanced capital account resulted in a substantial increase in official reserves, which reached US$800 billion by year-end.
Equity markets in the GCC countries rebounded after a major correction in 2006. The benchmark Saudi stock market index recorded a gain of 44 percent from a low at end-2006, but ended 2007 well below the peak of February 2006. The resurgence in market activity was driven by strong corporate profits in the petrochemical, banking, and construction sectors. The U.A.E. stock exchange index and the Doha Securities Market index performed strongly in 2007, ending the year with gains of 46 percent and 34 percent, respectively, but still below their peaks. In Pakistan, following a strong rally since mid-2005, heightened political uncertainties and security concerns weakened investor confidence toward the end of the year. The Karachi Stock Exchange Index dropped in the aftermath of former Prime Minister Benazir Bhutto’s assassination, while the Emerging Markets Bond Index Global (EMBIG) spread on Pakistani sovereign bonds rose to about 600 basis points (Figures 15 and 16).
Regionwide, there is also evidence of a rapid increase in real estate prices, although it is difficult to assess whether this reflects simply the changing fundamentals or whether prices are diverging from equilibrium levels.
Stock Market Indices in Selected Countries
(December 2006 = 100)
Source: Bloomberg.Sovereign Spreads in Selected Countries
(In basis points)
Source: Bloomberg.GCC countries comprise Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
Oil exporters comprise Algeria (DZA), Azerbaijan (AZE), Bahrain (BHR), Iran (IRN), Iraq (IRQ), Kazakhstan (KAZ), Kuwait (KWT), Libya (LBY), Oman (OMN), Qatar (QAT), Saudi Arabia (SAU), Syria (SYR), Turkmenistan (TKM), and the United Arab Emirates (UAE). Low-income countries comprise Afghanistan (AFG), Armenia (ARM), Djibouti (DJI), Georgia (GEO), the Kyrgyz Republic (KGZ), Mauritania (MRT), Sudan (SDN), Tajikistan (TJK), Uzbekistan (UZB), and Yemen (YMN). Emerging market countries include Egypt (EGY), Jordan (JOR), Lebanon (LBN), Morocco (MAR), Pakistan (PAK), and Tunisia (TUN). The country acronyms used in some figures are included in parentheses.
The CCA comprises Armenia, Azerbaijan, Georgia, Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan.
The Maghreb countries comprise Algeria, Libya, Mauritania, Morocco, and Tunisia.
The price of wheat, which is the staple food in most countries in the region, increased by 33 percent in 2007 on top of a 25 percent increase in 2006.
Kuwait switched to an undisclosed currency basket and Syria switched the referencing of its currency to the SDR.
