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Structural Reforms in Arab Countries

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1993
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TO EXPLOIT their considerable economic potential in the remainder of the 1990s, Arab countries will need to continue addressing structural weaknesses in their economies.

Despite having achieved important gains in recent years, many Arab countries remain subject to internal and external constraints that frustrate the full realization of their considerable economic potential. Accordingly, there is growing recognition among policymakers in the region of the need to strengthen the economic performance of these countries in a sustainable manner. This would involve implementing comprehensive measures to mobilize additional productive resources and to use them more efficiently.

Structural policy issues

The exact nature and magnitude of the structural policy challenges facing Arab countries vary depending on the country being considered. In addition to differences in economic and financial conditions—including the degree to which they were affected by the 1990–91 Middle East crisis—countries differ in the extent to which they have already embarked on comprehensive adjustment and reform programs. Nevertheless, many of them face similar policy challenges in the structural reform area. Such challenges are accentuated by rapid population growth in some countries, concerns about water supplies and oil price prospects, and the uncertain international environment facing the region. Several countries have responded to these challenges by implementing policies that address their basic structural weaknesses, while others are designing such policies.

Reforming public enterprises. An important feature of many Arab countries has been the dominant role played by the public sector.

The economic performance of public enterprises in Arab countries, however, has been disappointing in many cases. Earnings have tended to fall short of current financial obligations and do not provide for an adequate return on capital. In addition to direct transfers from the budget to cover losses, some of the enterprises have been provided with subsidized inputs and credit, further straining budgetary and monetary balances. In some countries, the banking system’s nonperforming claims on public enterprises have also weakened the integrity of the financial system.

As a result, some countries have provided enterprises with greater autonomy and accountability and have begun privatizing and financially restructuring them. While the scale of such policies has, on the whole, been limited relative to several other developing countries—reflecting institutional constraints, concerns about the absorption of surplus labor, and difficulties in addressing the large financial obligations of certain enterprises—a range of measures has been implemented. For most Arab countries, the initial step has involved assessing the financial viability of the enterprises and, in several cases, the rationale for public ownership and control. The next step has involved measures that range from a targeted privatization program (Tunisia) to the use of a holding company construct (Algeria and Egypt), transfers to workers’ cooperatives (Libya and Somalia), selected sales of shares (Oman, Qatar, and Saudi Arabia), use of management performance contracts (Algeria), and assumption by the central government of nonperforming enterprise obligations to the banking system (Mauritania).

Other fiscal sector reforms. The dominant role of the public sector has also been reflected in the structure and size of the central government budget. Almost all Arab countries have had to address large budgetary deficits, including oil economies, where the sharp decline in oil prices in the mid-1980s exposed the vulnerability of the fiscal accounts. In addition to containing appropriate expenditure (with emphasis on cutting nonproductive and low priority outlays), the needed effective and permanent reduction in fiscal imbalances has required measures that improve the structure of revenues. Without these, a series of politically difficult fiscal adjustments would be needed periodically to prevent the re-emergence of unsustainable fiscal imbalances—adjustments that, in the past, have tended in some countries to excessively constrain productive outlays on social sectors and infrastructure.

The key elements of tax reforms recently implemented in some Arab countries have included simplifying the tax system and rendering it more transparent, improving its buoyancy and elasticity, reducing antiproduction and anti-export biases, enhancing the redistributive features, and reducing the vulnerability of tax collections to adverse external terms of trade movements. This has involved reforming direct and indirect taxes and seeking to decrease the countries’ reliance on international trade taxation. The most comprehensive direct tax reforms, implemented in the Maghreb countries, have provided for a broadening of the tax base, elimination of multiple taxation of corporate profits, taxation of all individual income under the same tax schedule, rationalization of exemptions, and introduction of current year payments of realized tax liabilities among other things. On the indirect tax side, they have involved the replacement of various levies by a value-added tax. Other measures affecting indirect taxation have included the adoption of sales and consumption taxes (Egypt and Jordan, respectively) and shifting excises from a specific to ad valorem basis (Mauritania).

Financial sector reforms. As in other developing countries, the reform challenges in the financial sector of many Arab countries include three elements: rationalizing the deposit and lending rate structure, deepening money and capital markets in the formal sector of the economy, and strengthening prudential regulation and supervision. Such steps have implied a fundamental move away from systems characterized by strict controls over the rate structure supplemented by quantitative limits on the overall and sectoral allocation of credit. These systems had their origin in the desire to prevent usurious rates and provide instruments to channel credit to sectors deemed to constitute a national priority. In many cases, however, they contributed to financial disintermediation, currency substitution, and credit rationing.

A number of Arab countries have substantially liberalized their rate structures (Algeria, Bahrain, Egypt, Jordan, Morocco, and the United Arab Emirates). At the same time, steps were taken to move away from quantitative restrictions and toward indirect monetary control. Some Arab countries have also taken measures to strengthen capital markets. In addition to widening the scope of such measures, further steps are needed to deepen money and capital markets. In several cases, this would involve renewed efforts at institution building and improving existing procedures for governing trading, accounting, and reporting systems. Finally, appropriate strengthening of the prudential, regulatory, and supervisory regimes is important to counter potential risks arising from liberalization that could affect the integrity of the financial system.

Other domestic and external liberalization measures. Recognizing the adverse impact of rigid systems of administered prices, several Arab countries (e.g., Egypt and Sudan) have taken steps to liberalize their domestic pricing systems. Moreover, steps have been taken to address the multiplicity of same-product prices (e.g., Syria). Nevertheless, the process, while advancing, is not complete in many countries. As a result, the objective of establishing a “level playing field”—both operationally and legally—for private and public sectors is still some distance away.

The emphasis on public-sector led growth in the Arab region was also associated with an import-substitution strategy. Consequently, sluggish domestic competitive forces were compounded by a weakening of the disciplinary role of international competition. For most non-oil countries, the resulting inefficiencies in the tradeable sector were accompanied by pronounced vulnerability to adverse developments in international prices and demand conditions. In light of these tendencies, most Arab countries have begun to liberalize their external sectors, in particular by relaxing quantitative and tariff trade barriers, reforming the exchange and payments system, and enhancing foreign direct investment inflows.

Developments in the 1980s

For developing countries as a whole, the decade of the 1980s was a relatively disappointing one, characterized by considerably weaker economic performance compared with the 1970s (Chart 1). Specifically, economic growth was lower, consumer prices increased significantly faster, and external debt increased despite the curtailment in voluntary financing. Performance varied significantly among regional groupings, however, with the economies of Asia faring considerably better than those of Africa and Latin America.

The performance of Arab countries during the 1980s was mixed relative to that of developing countries as a whole. Real GDP expanded at an annual average of some 2 percent (Chart 2) which, in the context of a relatively high population growth, implied a decline in per capita income of some 1 percent a year. Inflation performance was considerably better than that for developing countries as a whole, notwithstanding the acceleration in the latter part of the decade (Chart 3). Finally, the group’s current account position improved after 1984, despite the sharp decline in exports resulting from lower oil prices (Chart 4).

As with the developing countries, macroeconomic aggregates for Arab countries as a whole conceal important differences among individual countries—countries which differ (substantially in some cases) in their natural resource bases, labor endowments, and financial resources. This is most apparent when comparing oil and non-oil countries’ growth performance—and despite strong interrelationships among the two groups as a result of remittance and aid flows, among other things. As would be expected, the fall in oil prices, compounded by a reduction in production and exports, affected growth performance in oil countries more severely. Thus, while non-oil countries’ per capita income gains exceeded those of developing countries as a whole, the oil countries recorded negative rates in several years during the 1980s. The non-oil Arab countries’ inflation performance was also better than that of developing countries as a whole but fell short of that of their oil neighbors.

Chart 1Developing countries’ economic performance weaker in the 1980s

Chart 2Growth of real GDP*

(annual changes in percent)

Chart 3Consumer prices

(annual changes in percent)

Chart 4Improvement of current account position in Arab countries

Source: International Monetary Fund, Data Fund.* Aggregates for Arab countries in this and other charts are compiled on the basis of computed GDP-weighted averages for countries of the Arab League for which comprehensive data are currently available.Note: For the purposes of the analysis, oil countries are defined as those deriving more than half of their domestic output from the extraction of crude oil. The group includes Algeria, Bahrain, Kuwait, Libya, Oman, Qatar, Saudi Arabia and the United Arab Emirates.

Protecting vulnerable segments of the population. A sound macroeconomic framework is essential to alleviate poverty. At the same time, there is growing recognition of the potential short-term adverse effects of adjustment and reform policies on the economically most vulnerable segments of the population. Therefore, reform efforts in Arab countries have increasingly included specific measures to protect vulnerable segments of the population. These have included comprehensive safety net systems (Tunisia), direct cash transfers (Algeria and Jordan), improved targeting of food subsidies (Jordan), and food-for-work programs (Mauritania). Some countries have also set up special funds which, with assistance from external creditors and donors, seek to finance projects designed to mitigate the adverse impact of adjustment and reform measures on dislocated segments of the labor force (e.g., the Social Fund in Egypt and the Employment and Development Fund in Jordan).

This article is based on a longer paper presented at a seminar on “Prospects of Arab Economic Development in the Nineties,” organized by the Arab Fund for Economic and Social Development and the Arab Monetary Fund in Bahrain on February 1–3, 1993. The paper will be included in the proceedings of the seminar edited by Said El-Naggar and published by the International Monetary Fund (English edition) and the Arab Fund for Economic and Social Development (Arabic version).

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