Recent Economic Developments

International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
October 2008
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Robust growth continues

The MCD region has continued to experience strong growth in 2008, outpacing global growth for the ninth year in a row (Figure 1). High commodity prices, strong domestic demand, and credibility of policy frameworks underpin an expected real GDP growth of 6½ percent in 2008, well above average growth since 2000. As a result, real GDP per capita is likely to grow by 5 percent in 2008, compared to 3 percent earlier this decade. And while growth in the MCD region is lower than in developing countries and emerging Asia—the region has nonetheless largely remained resilient to the ongoing international credit crisis and the downturn in developed economies.

Figure 1.Global Real GDP Growth

(Annual change; in percent)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

Among MCD countries, growth performance is anticipated to remain at the same level as in 2007 in oil-exporting countries, ease in low-income countries, and strengthen in emerging market countries (Figure 2):

Figure 2.Real GDP Growth in the MCD Region

(Annual change; In percent)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

  • Oil-exporting countries are expected to continue to grow at an average of 6½ percent (Figure 3). Average growth in the non-oil sector is expected to decline to 6¾ percent, ¾ percentage point less than in 2007, mainly reflecting spillovers from the global financial turmoil to Kazakhstan. In contrast, oil output growth is projected to double in this country grouping, with production increasing in Iraq (following the improvement in security), Libya, Oman, Qatar, and Saudi Arabia. With the depletion of reserves, oil GDP is expected to continue to fall in Bahrain and Syria, though at a slower pace than in 2007.

    Figure 3.Oil and Non-Oil Real GDP Growth in Selected Oil Exporters, 2008

    (Annual change; In percent)

    Sources: Data provided by country authorities; and IMF staff estimates and projections.

  • Average growth in low-income countries is estimated to moderate to 7 percent, essentially because of the impact of rising international food and fuel prices during the first half of the year. In addition, drought has affected agricultural output in Afghanistan, and winter weather–related electricity shortages have hit economic activity in Tajikistan.

  • Growth is likely to increase to 6½ percent in emerging market countries, driven mainly by a surge in foreign direct investment, including from the GCC countries. Other factors include a rebound in Morocco’s agriculture sector, and strong tourism in Lebanon. In contrast, the global economic slowdown and higher food and fuel prices are likely to lower growth in Jordan and Pakistan, and in Tunisia, economic activity is expected to decelerate because of a temporary drop in hydrocarbon production.

However, unemployment remains high in a number of countries in the region, reflecting a rapidly expanding labor force (Figure 4). Based on available data for about half of MCD countries, unemployment in the region is declining slowly, from 9¾ percent in 2004 to 9¼ percent in 2007.1 Among the countries for which data are available, the most significant unemployment reductions were in Algeria (from 17¾ percent to 13¾ percent) and Armenia (from 9½ percent to 7½ percent).

Figure 4.Unemployment Rate

(In percent)

Sources: Data provided by country authorities; and IMF staff estimates.

Inflation is a concern

Consistent with global trends, inflation has emerged as a key issue in MCD countries. The main sources of inflationary pressures differ, however, across country groupings. These range from the surge in food and fuel prices (Box 1), which has affected mostly low-income and emerging market countries, to strong domestic demand pressures and supply bottlenecks—particularly in the housing sector—in the GCC countries, to the weakening of the U.S. dollar, to which many MCD countries are pegged.

Box 1.Macroeconomic Implications of Higher Commodity Prices

Recent macroeconomic developments in the MCD region have in large part been driven by the high world commodity prices, which have had a significant impact on external balances and inflation. Countries have adopted a range of policy responses, some with a heavy fiscal cost, and many have boosted social safety nets.

Higher commodity prices have had a diverse impact on balance of payments across the region. Oil-exporting countries have overwhelmingly benefited. For some countries that export other commodities, higher non-oil export prices have offset the negative effects of imported food and fuel. However, external balances in many net commodity importing countries have been adversely affected, with the negative impact of higher world prices in 2007 exceeding 1 percentage point of GDP in some countries (Jordan, Pakistan, Tajikistan) (Figure B1.1), and a further widening is expected in 2008.

Figure B1.1.First-Round Impact of Commodity Price Changes on the External Current Account

(2007 over 2006, in percent of 2006 GDP)

Sources: IMF, World Economic Outlook; and IMF staff estimates.

Higher commodity prices have had a widespread impact on inflation. The latest observations in 2008 indicate that headline inflation in MCD countries has so far accelerated to 17 percent on average, from below 9 percent at end-2006. Food prices so far have had the largest impact, with an average contribution ranging from over 40 percent in oil-exporting and emerging market countries to over 70 percent in low-income countries—far more than the contribution of fuel (5 percent). This is mainly due to the weight of food products in consumption baskets, and the low pass-through of higher international fuel prices into domestic prices in many countries (see Box 2). Given the share of food in consumption baskets, rising food prices are of particular concern for emerging market and low-income countries.

Changes in world commodity prices typically account for about 40 percent of fluctuations in domestic headline inflation in the region, although there is considerable cross-country variation (Figures B1.2 and B1.3).1 World fuel price shocks have had a significantly smaller and more heterogeneous effect on inflation as compared to food price shocks, in line with the high share of food in consumption baskets and the incomplete pass-through of international fuel prices.

Figure B1.2.Contribution of Food to the Change in Headline Inflation

(end-2006 to latest observation in 2008, year on year)

Figure B1.3.Contribution of Fuel to the Change in Headline Inflation

(end-2006 to latest observation in 2008, year on year)

Domestic factors, such as monetary and exchange rate policies, and inflation history also have a noticeable effect on headline inflation. Notably, inflation inertia is considerably lower in countries where inflation has been contained in the past (Figure B1.4). The overall size of the inflationary impact of external and domestic shocks differs across countries due to consumption patterns, cost structures of domestic production, as well as policy reactions.

Figure B1.4.Contribution to Variation in Inflation, 1999–2008

(After 24 months; in percent)

Sources: IMF, World Economic Outlook; and IMF staff estimates.

Higher commodity prices feed through into core inflation (excluding energy and food). The spillover of world food and fuel prices to core inflation indicates that price shocks could exacerbate inflation. Such risks are elevated for countries where domestic demand has been growing strongly. Moreover, spillover effects are more significant in countries that have experienced high inflation in the past, suggesting that second-round inflationary impacts depend on how well inflation expectations are anchored.

Countries in the region have resorted to a wide range of policy actions in order to contain inflation and alleviate its social impact. Many countries have adopted one-off, temporary measures to ensure food availability and protect the incomes of the poor. Although the overall fiscal costs of these measures have generally been small, the cost of universal food and fuel subsidies is projected to be significant for a number of countries (Egypt, Pakistan, Turkmenistan, and Yemen).

  • Tax cuts. Reductions in import tariffs on major food staples have been the most common response across the region. Several countries have also cut value-added tax (VAT) rates or suspended VAT on selected food items (Jordan, Kyrgyz Republic, Morocco), or lowered excises and other duties on fuel.

  • Consumption subsidies. Universal subsidies prevalent before the onset of price hikes have risen in many cases, especially for basic foodstuffs (Egypt, Jordan, and Pakistan), fuel and energy (Morocco, Yemen) or fertilizers (Azerbaijan, Pakistan).

  • Price controls. Adjustments to domestic energy prices have often not kept pace with international price developments in many countries (Box 2). Price ceilings on food distribution margins have been imposed in Djibouti, while the United Arab Emirates has frozen the price of 18 basic foodstuff prices at 2007 levels.

  • Trade restrictions. A number of countries have sought to protect domestic supplies of food. For example, wheat and rice exporters, such as Egypt, Kazakhstan, and Pakistan, have imposed export restrictions either in the form of outright bans or increased taxes related to food exports.

  • Social safety nets. Many governments have boosted social safety nets. Interventions have included direct food distribution (Mauritania), scaling-up of targeted income support (Jordan, Saudi Arabia, and Yemen), and school feeding programs (Kyrgyz Republic). In certain countries (Azerbaijan, Kyrgyz Republic, Morocco, and Uzbekistan), low-wage civil servants have received wage increases.

  • Supply-side measures. To stimulate domestic food production, several governments have started providing agricultural inputs (Azerbaijan) and subsidized credit to rural producers (Tajikistan).

1 A recent IMF staff study disentangles the impact on inflation of different external and domestic factors, by estimating a vector autoregressive model (VAR) for 16 countries over the period 1999–2008. The model uses monthly data on annual changes in world food and fuel prices, nominal effective exchange rates, broad money, and headline and core inflation.

Average consumer price inflation in the MCD region is projected at 15 percent in 2008 (Figure 5a), well above the average of all developing and emerging market countries. The aucasus and Central Asia (CCA) is expected to record the highest regional inflation in the world (17 percent), with rates surpassing 20 percent in Azerbaijan, Kyrgyz Republic, and Tajikistan. Inflation in the GCC is also expected to be in double digits in the wake of strong demand pressures (Figure 5b), and Iran’s expansionary policies are likely to cause inflation to rise to 25 percent, despite price controls on several food items. In contrast, inflation in the Maghreb is expected to remain contained at 5¾ percent, reflecting sound policies, as well as the use of food and fuel subsidies. In Iraq, a policy package that includes exchange rate appreciation, monetary tightening, fiscal discipline, and measures to reduce fuel shortages has reduced inflation sharply.

Figure 5a.Consumer Price Inflation: Country Aggregates

(Average; annual change; in percent)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

Figure 5b.Consumer Price Inflation: Individual Countries

(Average; annual change; in percent)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

Core inflation (excluding energy and food) is rising in a number of countries, including Egypt, Kazakhstan, Kyrgyz Republic, and Yemen, and reached double digits in the MCD region (Table 1 presents the most recent observations through mid-2008). There are concerns that inflation expectations may have started to increase—particularly in cases where wage pressures and buoyant domestic demand might fuel second-round effects. Wages have been increased in more than half of MCD countries during 2007–08, partly to soften social tensions from the decline in real wages and purchasing power. Civil service wage increases have ranged from 10 percent on average in Mauritania to 80 percent in Uzbekistan, while in Azerbaijan the minimum wage has increased by 150 percent (see Table 2). The decision by a number of governments in the region to limit the pass-through of world oil prices to domestic petroleum products has helped contain inflation, but at an increasing fiscal cost (Box 2).

Table 1.Food, Fuel, and Headline Inflation(12-month percentage change, latest observation in 2008)
Headline InflationFood Inflation1Fuel Inflation1Core Inflation2
MCD countries317.022.615.110.8
Oil exporters15.920.418.211.0
Low-income countries19.025.812.010.1
Emerging markets18.926.511.910.6
Sources: Data provided by country authorities; and IMF staff estimates.
Table 2.Wage Increases in MCD Countries (2007-08)
CoverageSize of Increase
AfghanistanMinimum wage in the civil service12 percent
ArmeniaCivil service wages24 percent
AzerbaijanMinimum wage150 percent
EgyptCivil service wages20 percent
GeorgiaAll wages35 percent on average
IranMinimum wage and civil service wages46 percent and 14 percent, respectively
IraqCivil service wages40 percent
JordanCivil service wagesJD 45-50 per month
KuwaitCivil service cost of living allowanceKD 150, and KD 50 for wages < KD 1,000
Kyrgyz RepublicCivil service wages30-80 percent
LebanonMinimum wage and civil service wages15-17 percent on average
LibyaCivil service wages50 percent
MauritaniaCivil service wages10 percent
MoroccoMinimum wage and low civil service wages5 percent
OmanCivil service wages5-42 percent
PakistanCivil service wages38 percent
QatarCivil service wages30 percent
Saudi ArabiaCivil service wages15 percent over 3 years
SyriaCivil service wages56 percent
TajikistanCivil service wages40 percent
TurkmenistanCivil service wages10 percent
United Arab EmiratesCivil service wages20-70 percent
UzbekistanCivil service wages80 percent
YemenCivil service wages25-35 percent
Sources: Country authorities; and IMF staff estimates.

Box 2.Pass-Through of International Oil Prices in MCD Countries

The pass-through of higher international oil prices to domestic prices for petroleum products has been incomplete in most MCD countries. This has led to higher subsidies but also helped to mute inflation pressures.

While retail prices for oil products have increased in most MCD countries, price differences across countries have widened (Figure B2.1). In general, oil products are relatively cheap in oil-exporting countries and more expensive in oil importers. Moreover, the dispersion of gasoline prices across countries (measured by the standard deviation of gasoline retail prices) has doubled over the period 2003–08, reflecting different pricing and tax regimes.

Figure B2.1.Retail Prices for Oil Products in MCD Countries

(In U.S. dollars per liter, end of period)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

Very few countries have fully passed through the rise in world fuel prices to retail customers. Retail fuel prices in most MCD countries remain well below international levels (e.g., compared to prices in the United States) (Figure B2.2). The pass-through from international to domestic retail gasoline prices between end-2003 and mid-2008 (defined as the ratio of the absolute change in domestic gasoline prices to the equivalent change in the United States1) was only partial in most countries. The average degree of pass-through for all MCD countries is about 40 percent, but there is significant cross-country and regional variation:

Figure B2.2.Domestic Price of Unleaded Gasoline Relative to U.S. Prices

Sources: Data provided by country authorities; and IMF staff estimates and projections.

  • Pass-through was highest for low-income countries (70 percent); the GCC recorded the lowest pass-through (25 percent).

  • Pass-through is larger than 100 percent in Georgia, and Mauritania, reflecting these countries’ liberalized fuel price regimes.

Low pass-through has been associated with explicit or implicit fuel subsidies. Explicit subsidies mainly reflect budgetary compensation to national energy or refining companies, and are expected to exceed 3 percent of GDP in 2008 in three countries: Egypt, Morocco, and Yemen. Explicit subsidies have generally increased in countries that have relied on universal fuel subsidies for their safety net, except in Jordan, where subsidies for virtually all petroleum products were removed in early 2008. Implicit subsidies, which reflect domestic sales of fuels at below export prices, with no explicit compensation from the budget, are more prevalent among oilexporting countries. While implicit subsidies are much harder to measure, estimates range from 2.5 percent of GDP (United Arab Emirates) to over 17 percent of GDP (Iran) in 2008.

1 Various studies find that pass-through in the U.S. gasoline market is quite rapid (full pass-through occurs within two months).

Inflation has offset nominal exchange rate depreciations

Continuing the appreciation trend of recent years, the region’s average real effective exchange rate appreciated by 3 percent between June 2007 and June 2008 (Figure 6). However, in nominal effective terms, exchange rates depreciated on average by 4½ percent over the same period (Figure 7). The lack of exchange rate flexibility in several countries has contributed to a build-up of inflationary pressure, by forcing the adjustment of the real exchange rate through domestic inflation.

Figure 6.Real Effective Exchange Rates

(Index, 2000 = 100; increase indicates appreciation)

Source: IMF Information Notice System.

Figure 7.Nominal Effective Exchange Rates

(Index, 2000 = 100; increase indicates appreciation)

Source: IMF Information Notice System.

Terms of trade are positive, external balances stronger

External positions continue to strengthen in 2008 despite a larger import bill resulting from higher food prices. The current account surplus of MCD countries is expected to increase markedly, from 14½ percent of GDP in 2007 to an estimated 19 percent in 2008 (Figure 8). This projected improvement is accounted for mainly by commodity-exporting countries (including oil exporters), which have benefited from the sharp increase in commodity prices.

Figure 8.External Current Account Balance

(In percent of GDP)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

  • The current account surplus in oil-exporting countries is expected to reach 25 percent of GDP (US$540 billion) in 2008, an increase of US$228 billion (or 74 percent) from 2007. With oil prices expected to be on average 50 percent higher in 2008 than in 2007, this expansion reflects substantial savings of this year’s additional oil export receipts. The current account balance is expected to deteriorate in Iraq (as investment-related imports rise, and inflows of foreign grants diminish) and in Syria (reflecting the steady decline in oil exports).

  • The current account deficit in low-income countries is likely to narrow in 2008, from an average of 5 percent of GDP to 2¼ percent. This progress mainly reflects improved terms of trade in commodity-exporting countries (e.g., Mauritania, Sudan, Uzbekistan, and Yemen) and buoyant remittances in Tajikistan.

  • External positions are expected to deteriorate in most emerging market countries. Overall, the current account deficit of this grouping is projected to widen by 1½ percentage points of GDP, with particularly large deficits in Jordan and Lebanon. This deterioration mirrors again higher food and fuel import bills in all countries, as well as higher foreign direct investment (FDI)-related imports and strong domestic demand in Egypt, Lebanon, and Tunisia.

The steady rise in oil prices since 2003 has contributed to booming gross FDI inflows to the region, from US$18 billion in 2002 to US$94 billion in 2008. The largest share of these inflows is directed toward the oil sector in oil-exporting countries, but low-income and emerging market countries are also enjoying higher FDI inflows. Many of these inflows are intraregional, originating from the GCC and reflecting investment of oil revenue abroad. Negative net FDI inflows to oil-exporting countries suggest that these countries are investing part of their oil revenue abroad (Figure 9).

Figure 9.Net Foreign Direct Investment, 2008

(In billions of U.S. dollars)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

A recent study of economic linkages between the GCC and other countries in MCD suggests that the oil boom in the GCC states has had positive spillover effects.2 The study finds that real GDP growth in regional countries is strongly associated with the accumulation of financial surpluses and the growth of remittance outflows from the GCC. The presence of countervailing financial and remittance flows from the GCC helps explain why growth in oilimporting countries in the region has continued to be buoyant, notwithstanding the recent sharp increases in oil prices.

Other capital flows (i.e., non-FDI) have remained largely untouched by the ongoing global credit crunch. In this setting, a large current account surplus and a balanced capital account are expected to result in a substantial increase in MCD countries’ official international reserves (Figure 10). Gross official reserves of the region have increased almost fivefold in the last five years, and are set to surpass US$1.1 trillion at end-2008, US$260 billion higher than at end-2007. Reserves have increased in all country groupings, but oil-exporting countries dominate the picture: their reserves are expected to be over US$1 trillion by end-2008. In most low-income and emerging market countries, capital inflows have more than offset current account deficits and allowed for a slight accumulation of reserves. In some oil-exporting countries, a portion of oil receipts has been managed by special-purpose government funds—sovereign wealth funds (SWFs)—(e.g., Abu Dhabi Investment Authority and Qatar Investment Authority) and are not included in official reserves. SWFs have a long-term investment horizon and focus more on generating higher returns on their portfolio than central banks typically do. An International Working Group of Sovereign Wealth Funds—comprising 26 countries, and facilitated by the IMF—has reached agreement on a draft set of voluntary, generally accepted principles and practices (GAPP) that reflects the current practices of SWFs or actions to which they aspire. The GAPP is intended to guide the conduct of investment practices by SWFs and covers areas of the legal framework, governance and institutional structures, and investment policies and risk management.

Figure 10.Gross Official Reserves

(In billions of U.S. dollars)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

Fiscal policy is generally sound

Driven by the oil exporters, government savings are expected to increase substantially in MCD countries, with the total fiscal surplus rising from an average of 5½ percent of GDP in 2007 to 8¾ percent in 2008 (Figures 11a and 11b). Fiscal consolidation, together with the use of privatization receipts and earmarked oil revenues in some countries, and/or the repayment of arrears or external debt in others, is likely to reduce the ratio of government debt to GDP to less than 30 percent at end-2008 (Figure 12). Despite this progress, however, the level of indebtedness remains above 60 percent of GDP in Egypt, Jordan, Lebanon, and Mauritania.

Figure 11a.Government Fiscal Balance: Country Aggregates

(In percent of GDP)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

Figure 11b.Government Fiscal Balance: Individual Countries

Sources: Data provided by country authorities; and IMF staff estimates and projections.

Figure 12.Total Government Debt

(In percent of GDP)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

  • With fixed exchange rate regimes in most oil-exporting countries, fiscal policy has been the main demand-management tool available to contain inflation. Accordingly, some countries have aimed to contain demand pressures in 2008 by slowing the growth in current spending (Figure 13) and addressing supply bottlenecks through higher capital investment. The average saving rate of fiscal oil receipts—the ratio of overall fiscal balance to fiscal oil receipts—is estimated to increase from 42 percent in 2007 to 49 percent in 2008.3 Nevertheless, the non-oil fiscal deficit of oil-exporting countries is projected to widen slightly to 37¼ percent in 2008, mainly due to a planned fiscal expansion in Iraq, with higher investment, an increase in public sector wages, and other essential current spending.

Figure 13.Nominal Growth Rate of Government Expenditure in Oil Exporters

(Annual change; in percent)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

  • The fiscal positions of low-income countries have improved markedly, despite an increase in spending in an environment of rising food and fuel prices. Strong value-added tax (VAT) performance and buoyant revenue from income and trade taxes, as well as oil and other commodity-related revenues in some countries, have helped reduce the average deficit of these countries to an estimated 1 percent of GDP in 2008.

  • The budgetary impact of the policy response to higher food and fuel prices has been pronounced in emerging market countries, in particular in Morocco and Pakistan. The average fiscal deficit of this country grouping is likely to widen to 6½ percent of GDP in 2008, though fiscal consolidation has continued so far in Lebanon.

Monetary policy options are limited

MCD countries’ monetary aggregates are expected to grow strongly, suggesting a generally accommodative monetary policy stance, although there was some tightening in CCA countries, where inflation was the highest. Broad money growth is expected to continue at about 25 percent in 2008 (Figure 14), which risks further fueling inflationary pressures in some countries. This acceleration mainly reflects the difficulty in tightening monetary policy, which is constrained by the relative inflexibility of most MCD currencies vis-à-vis the U.S. dollar.

Figure 14.Broad Money Growth

(In percent) projections.

Sources: Data provided by country authorities; and IMF staff estimates and projections.

  • With most oil-exporting countries’ exchange rates pegged to the dollar, monetary policy has been generally linked to U.S. policies at a time when the discrepancy between their business cycle and that of the U.S. economy has been widening. Because of the peg, most central banks have had to lower interest rates following the monetary easing in the United States. This has contributed to spurring strong private sector demand for credit and caused real interest rates to become increasingly negative. To slow credit expansion—estimated at 25½ percent at end-2007—several central banks have increased reserve requirements and expanded open market operations to mop up liquidity.

  • In low-income countries, money and credit to the private sector are expected to grow at a slower pace than in 2007, in response to policy tightening (Figure 15). Nevertheless, growth of monetary aggregates in these countries has been strong in recent years, reflecting remonetization and further financial deepening. Thus, this has not added to inflationary pressures. Broad money growth is expected to decline to 23 percent in 2008, and private sector credit growth to 18½ percent.

Figure 15.Money and Credit to the Private Sector in Low-Income Countries

(Annual change; in percent)

Sources: Data provided by country authorities; and IMF staff estimates and projections.

  • Most central banks in emerging market countries have been in a tightening cycle and allowed interest differentials against the United States to widen with the view to reining in inflationary pressures and credit growth. Egypt, for example, has raised its policy rates by 275 basis points in 2008. As a result, growth in credit to the private sector and growth in broad money are expected to decelerate to 15½ percent in 2008 in emerging-market countries.

The impact of the global credit crunch on financial markets is mixed

Most equity markets in the region are down—some considerably so—from highs achieved in late 2007 and early 2008. Among the oil exporters, the GCC stock markets, in particular, have experienced sharp drops this year (Figure 16), with investor confidence affected by global developments, inflation, and concerns about real estate markets (Dubai and Saudi Arabia). In emerging markets, the picture is mixed, as some markets with strong economic fundamentals (Tunisia) have proved resilient to the global credit turmoil, while others (Egypt) have seen their equity markets fall significantly.

Figure 16.Selected Stock Market Indices

(December 31, 2005 = 100)

Source: Bloomberg.

The global credit crunch has affected foreign and domestic fixed income instruments differently. Sovereign spreads widened in all countries in the region during the first half of 2008, except in Lebanon due to an improvement in the political situation (Figure 17). Spreads in the MCD region widened further in September 2008 in response to the renewed onset of market turmoil in the United States; in Pakistan spreads have increased over 1,000 basis points since last year due to the macroeconomic and political uncertainties.

Figure 17.Sovereign Spread in Selected Countries

(June 2007–June 2008)

Source: Bloomberg.

Note: EMBIG = Emerging Market Bond Index Global (JPMorgan).

Domestic bond markets have remained relatively steady in most countries. However, in Lebanon, Treasury bill auctions have been continuously oversubscribed in light of large capital inflows, while in Egypt, interest rates on Treasury bills have jumped in 2008 partly due to the removal of the interest income exemption on Treasury bills. In Kazakhstan, spreads of credit default swaps on both the sovereign and banks have widened noticeably, as external financing has been sharply curtailed.

Banking systems remain sound

With strong economic fundamentals and little exposure to the U.S. credit markets, banking sectors in the region remain generally sound. Several countries have also emerged as important regional financial centers (Box 3). Prudential indicators continue to be strong in most countries, with capital adequacy ratios ranging from 8 percent to 29 percent (Table 3). Progress has also been made in improving banking supervision in the region. Nevertheless, the banking sector remains heavily dominated by public banks in some countries (e.g., Algeria, Egypt, Iran, Iraq, Mauritania, Syria, Turkmenistan, and Uzbekistan), slowing the development of the sector in these countries.

Box 3GCC Financial Centers—From Regional to International Focus

The emergence of new financial centers in the GCC has created a healthy competitive environment in local and regional financial markets. Can they become truly global players?

Massive investments by national governments in financial infrastructure and huge investment opportunities in the region have helped the development of new financial centers in the GCC. Bahrain has played a leading role in the GCC countries’ financial development, having established the first offshore banking center in the early 1970s. The establishment of the Dubai International Financial Center (DIFC) in 2004 and the Qatar Financial Center (QFC) in 2005 has resulted in the emergence of regional hubs.1 The GCC financial centers have somewhat different objectives, minimizing to some extent overlaps between them. In particular, while DIFC’s strategy is to serve as a gateway for the flow of capital to and from the region, QFC has been created as an integral part of the development and diversification of Qatar’s economy, leading to differences in the operations of these centers (Table B3.1). The growth of these financial centers has also been spurred by sharp increases in economic activity in the region and the need for substantial financial intermediation.2 The financial centers, which have attracted key players3 and a highly skilled labor force, are contributing to a healthy competitive environment in local, regional, and global financial markets. Their future as modern international financial centers will likely depend on maintaining a strong and transparent regulatory framework, continuing innovation, and making improvements in human capital, business environment, and market access.

Table B3.1.Financial Centers in the GCC: A Comparison
Central Bank of BahrainDubai International Financial CenterQatar Financial Center
Year established197320042005
RegulatorCentral Bank of BahrainDubai Financial Services AuthorityQatar Financial Center Regulatory Authority
Activities permittedWholesale and retail banking, Islamic finance, investment banking, insurance and reinsuranceWholesale banking, Islamic finance, investment banking, capital market services, reinsuranceWholesale banking, Islamic finance, investment banking, insurance and reinsurance
Permitted currenciesNo restrictionsCannot accept deposits in United Arab Emirates DhiramNo restrictions
LocationAnywhere in BahrainWithin designated jurisdictionAnywhere in Qatar
Employment restrictionsBahrainization appliesEmiritization does not applyQatarization does not apply
Ownership100 percent foreign ownership permitted100 percent foreign ownership permitted100 percent foreign ownership permitted
Tax regimeNo corporate tax for banks50-year tax holidayUp to 10 percent tax on profits from May 1, 2008. Tax exemptions for reinsurance

The financial centers are becoming increasingly important globally. More than 400 financial institutions operate in Bahrain compared to 170 in 2001, 149 of which are banks with total assets of around US$190 billion. DIFC has registered over 320 companies, of which about half are in financial and ancillary services.

Dubai International Financial Exchange (DIFX), with a market capitalization of $40 billion,4 is an international stock exchange located in the DIFC and regulated by the Dubai Financial Services Authority.5 The Qatar Financial Center Authority has licensed 78 companies (about two-thirds of which are in financial services). In March 2008, the Global Financial Centers Index (GFCI), which ranks financial centers based on external benchmarking data and current perceptions of competitiveness, ranked DIFC, Bahrain, and QFC at 24, 39, and 47, respectively, out of 66 centers, highlighting their emerging roles as global financial centers (Table B3.2). The ability of the three centers to continue growing in importance will depend on improving competitiveness, in particular in financial infrastructure.

Table B3.2.Top 10 Financial Centers
Financial CenterRank
New York2
Hong Kong3
Source: City of London Corporation, Global Financial Centers Index 3.

The financial centers could foster a vibrant market for Islamic products. In 2007, the GCC region held 36 percent of global sharia assets, which are estimated at US$500 billion (Figure B3.1).6 DIFC has already established a strong presence in this market with about US$16 billion listed in the DIFX (through mid-2007). Bahrain has played a pioneering role in Islamic banking, being the first country to develop and issue Sukuk (Islamic bonds), and has implemented a regulatory framework for Islamic banks and Islamic insurance and reinsurance. The Central Bank of Bahrain is now set to launch the Islamic Sukuk Liquidity Instrument, which will enable financial institutions—both conventional and Islamic—to access short-term liquidity against Government of Bahrain Islamic leasing (Ijara) bonds (Sukuk). By developing standardized, sophisticated, and liquid Islamic products, the GCC countries could establish a global competitive advantage in this field.

Figure B3.1.Geographical Distribution of Reported Sharia-Compliant Assets (US$500 billion), 2007

Source: The Banker, November 2007.

4 DIFX is made up mainly of equities and structured products (US$8 billion each), Sukuk (Islamic bonds; US$16 billion), and conventional bonds (US$7 billion).5 DIFX provides a dollar-denominated trading platform for international issuers to raise capital and debt through conventional and Islamic instruments.6 “Top 500 Islamic Institutions,” The Banker, November 2007.
Table 3.Capital Adequacy Ratio in MCD Countries(Regulatory Capital to Risk-Weighted Assets - Basel I Definition; in percent)
Egypt15.1Dec-06Saudi Arabia20.6Dec-07
Kuwait20.4Sep-07United Arab Emirates13.3Jun-08
Kyrgyz Republic28.8Jun-08Uzbekistan23.8Dec-07
Sources: Country authorities; and IMF staff estimates.

Contagion from the global financial turmoil was initially confined to Kazakhstan’s financial sector, where the sudden stop in external financing led to a domestic credit crunch, a sharp slowdown in growth, and a subsequent deterioration in banks’ asset quality. More recently, the central bank of the United Arab Emirates introduced a liquidity support facility of US$14 billion. This facility aims to address the tight liquidity conditions in the United Arab Emirates that have resulted from ongoing difficulties in global interbank markets, the unwinding of speculative positions in Gulf currencies—as a revaluation was seen as less likely owing to the renewed commitment to monetary union in 2010—and rapid growth in bank lending. Kuwait has introduced a similar facility for its banks. The rest of the region has to date been broadly unaffected by the tightened global financial conditions, mainly because of the dominance of domestic and regional investor bases, the positive economic prospects, and, in some cases, limited integration with international markets.

Data on unemployment are available for only 17 MCD countries (6 oil-exporting countries, 6 low-income countries, and 5 emerging market countries).

“Do the Gulf Oil-Producing Countries Influence Regional Growth? The Impact of Financial and Remittance Flows,” by Nadeem Ilahi and Riham Shendy, IMF Working Paper WP/08/167, 2008. Regional countries are Egypt, Jordan, Morocco, Pakistan, Sudan, Syria, Tunisia, and Yemen. The GCC is not a major trading partner of these countries.

The cumulative increase in the overall fiscal surplus since 2003—that is, the savings from the increase in oil revenue—expanded from 56 percent of the increase in fiscal oil receipts to more than 58 percent.

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