Chapter

II. Middle Eastern Oil Importers: Delayed Slowdown Under Way

Author(s):
International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
May 2009
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With relatively limited links to global financial markets, the Middle Eastern Oil Importers (MEOIs) have generally escaped the ravages of the global financial crisis. As the global recession deepens, however, MEOIs face weaker prospects for exports, foreign direct investment (FDI), tourism, and remittances. Consequently, MEOI growth is slowing too, but with a lag and more moderately than in advanced economies, and financial sectors in MEOIs are becoming more vulnerable. Most governments are unable to respond with significant fiscal stimulus owing to the limited fiscal space available. As a result, unemployment and poverty could rise substantially—with adverse implications for social stability. Therefore, in low-income countries, an increase in donor financing will be necessary to maintain aggregate demand and enhance social safety nets.

Middle Eastern Oil-Importing Countries

The MEOI group of countries is diverse in terms of geography, level of development, and integration with global and regional markets. Per capita income levels vary widely, as do poverty rates within the group. In terms of nominal GDP, the group is dominated by Egypt and Pakistan (75 percent). Although more diverse in terms of economic structure than the MEOEs and the CCA, the MEOIs do share some common features—including close economic and trade ties with the GCC and Western Europe, lower levels of financial development and integration with world financial markets, and higher levels of public debt.

Note: The country names and borders on this map do not necessarily reflect the IMF’s official position.

Limited impact of global crisis so far . . .

The global financial crisis has played out differently among countries in the group but, as a whole, the financial sectors in the MEOIs have weathered the first round of the crisis reasonably well. Stock markets in the region were hit hard during 2008 in the wake of the first round of the world crisis and diminished investor appetite. With the exception of Egypt and Pakistan, however, the decline in stock markets was generally less pronounced than the global emerging market average (Figure 7).

Figure 7.MEOIs: Change in Stock Market Indices

(In percent; Jan. 1, 2008–Mar. 6, 2009)

Source: Bloomberg.

For some emerging markets (Egypt, Lebanon, Pakistan), the pressure from financial turbulence in the more advanced economies has also had an impact through reduced access to international capital markets, lower deposit inflows, and higher rollover risk. However, with the exception of Pakistan, sovereign debt premiums have been no higher than the emerging market average (Figure 8).

Figure 8.Sovereign Bond Spreads

(In basis points; January 1, 2008–March 31, 2009)

Source: Bloomberg.

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

There have been no significant runs on banks in the MEOI countries, nor notable bank failures. The resilience of the banking system in the MEOI group reflects, for the most part, the limited foreign exposure of commercial banks, and their relatively high level of liquidity (Table 4). A few restrictions on capital account transactions also remain in some countries. One country (Jordan) instituted a blanket guarantee on bank deposits, while Egypt reiterated an existing blanket guarantee.

Table 4.Financial Soundness Indicators, 20081(In percent)
Capital

Adequacy Ratio
NonPerforming

Loans
Return on

Assets
Return on

Equity
Afghanistan14.61.82.0
Djibouti8.316.02.442.0
Egypt14.916.50.814.4
Jordan18.34.21.411.5
Lebanon11.83.11.114.0
Mauritania31.928.02.814.1
Morocco10.76.81.419.0
Pakistan12.29.11.211.3
Syria12.95.30.817.2
Tunisia10.316.70.910.6
Sources: Data provided by country authorities; and IMF staff estimates.

Or latest available.

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

Or latest available.

While evidence of financial contagion appears to have been limited and centered on the few countries in the group with significant ties to international capital markets, there remains the risk of second-round effects from the global recession. Slower trade and investment, sliding economic performance, and pressure on corporate balance sheets could eventually play through to the financial sector in the form of nonperforming loans.

. . . but impact of the crisis will intensify in 2009

The global financial crisis and recession will weigh on growth in the MEOIs. Because the direct impact of the global financial crisis on these countries has been limited, average growth held up well in 2008, boosted also by strong levels of FDI. The prospects for 2009 are extremely uncertain, and in these circumstances, projections must be considered to be only indicative (Figure 9). Looking ahead, however, it does seem likely that the slowdown in growth in the MEOIs’ main trading partners will adversely affect exports, tourism, workers’ remittances, and FDI. And the ongoing credit crunch will limit access to international capital markets. Real GDP growth for the group is projected to halve to 3.2 percent in 2009 from 6.2 percent in 2008.

Figure 9.MEOIs: Real GDP Growth

(In percent)

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

The MEOIs will be affected to different degrees by economic developments in their main trading partners, particularly the GCC and Europe. Strong countercyclical policies in the GCC should help cushion the impact on their own growth, and thereby on growth in their MEOI trading partners (Box 3).

Inflation will decline further

Average inflation for the MEOI group surged in 2008—driven for the most part by the sharp rise in international food and oil prices. Afghanistan, Djibouti, Jordan, Lebanon, and Syria recorded the most marked increases in inflation, reflecting their high dependence on imports of food and fuel.

The reversal in international food and commodity prices had dampened inflation in most countries in the group by year-end, however. Gloomy prospects for global economic growth and demand are likely to put further downward pressure on prices for food, fuel, basic commodities, and industrial inputs in the current year. For the MEOIs as a group, average annual consumer price inflation is projected to fall to 9.7 percent in 2009, from 14.4 percent in 2008, in large part owing to softer food and fuel prices. In some countries, inflation looks set to fall by at least half (for example, in Afghanistan, Djibouti, Jordan, Lebanon, and Syria). Significant reductions are also expected for most other countries in the MEOI group (Figure 10).

Figure 10.Consumer Price Inflation

(Average; annual changes in percent)

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

Box 3.Linkages and Spillovers with the GCC Region and with Europe

Most MEOIs have strong economic and financial ties with the Gulf region and/or Europe, including foreign direct investment, migration, and remittances. Countries in North Africa generally have stronger ties with Europe, while countries in the Middle East have closer linkages with the GCC.

North African countries’ share of merchandise exports to Europe ranges from 35 percent in Egypt to over 75 percent for Tunisia (Figure B3.1). With the exception of Egypt, these countries are also more dependent on Europe than on the GCC for remittances, with more than half of remittance flows to Mauritania, Morocco, and Tunisia originating in the European Union.

Countries in the Middle East tend to depend more on the GCC for remittances (Figure B3.2). For Lebanon, with up to 400,000 Lebanese living in the Gulf region more than half of remittance inflows originate from the GCC. Recent data for Pakistan show that, in 2008, remittance flows from the GCC countries accounted for 52 percent of total remittance inflows. In Jordan, the GCC accounts for an estimated 60–70 percent of total remittances, while flows from the European Union are much smaller. Trade patterns in the MEOIs are more diversified. For example, over 25 percent of Lebanon’s merchandise exports go to the GCC, and almost 40 percent of Pakistan’s exports go to the United States and Asia.

Reliance on foreign direct investment (FDI) varies considerably by country, ranging from 2½ percent of GDP (Afghanistan) to 30 percent of GDP (Djibouti). In recent years, Arab cross-border investment has become deeper and broader, reaching more countries and encompassing a growing number of sectors. Much of the FDI comes from the GCC countries. Direct investment flows from the GCC accounted for about 60 percent of total FDI inflows to Lebanon over the period 2002–07, more than half of which related to real estate investment. About 70–80 percent of FDI flows to Jordan in recent years has been from Arab sources. In contrast, the European Union is the main source of FDI for the North African countries.

Figure B3.1.Merchandise Exports, 2007

(In percent of total)

Source: IMF Direction of Trade Statistics.

Figure B3.2.Remittances, 20061

(In percent of total)

Sources: State Bank of Pakistan; Lebanese authorities; World Bank; and IMF staff estimates.

1 Pakistan and Lebanon data are for 2008. Other remittances in Lebanon include EU-15.

Note: This box was prepared by Rina Bhattacharya.

Real exchange rates mostly appreciating . . .

While most MEOIs sought to maintain a steady nominal exchange rate vis-à-vis either the dollar, the euro, or a basket of currencies, there were some marked changes in real effective exchange rates (REER) reflecting relative movements among the major international reserve currencies as well as high inflation in many of the MEOI countries. In real effective terms (that is, trade weighted and taking into account differences in inflation), exchange rates of most MEOIs appreciated—an average rise of 17 percent among Djibouti, Egypt, Jordan, Lebanon, Mauritania, and Syria (Figure 11).

Figure 11.Effective Exchange Rates

(Annual percent change; January 2008–January 2009)

Source: IMF Information Notice System.

. . . but moderate improvements in current accounts still expected

Despite the REER appreciation, the average MEOI current account deficit is projected to decline moderately in 2009, helped by lower food and fuel import prices (Figure 12). While the global financial crisis and recession have had varying effects on the external positions of the MEOI, the group as a whole is projected to experience a slight improvement in the current account from an average deficit of 5.0 percent of GDP in 2008 to 4.5 percent of GDP in 2009. Exports of goods and services from the group are projected to fall by some $21.7 billion between 2008 and 2009, with the most notable declines in Egypt (reflecting weaker tourism and Suez Canal receipts, as well as the impact of lower prices on hydrocarbon exports), Jordan (lower mining export prices), Tunisia and Morocco (textiles, basic manufactures, and some hydrocarbon exports), and Syria (hydrocarbon exports and agricultural commodities). Tourism from the Gulf states and Europe—an increasingly important source of income in recent years—is also expected to fall in the wake of the global recession. The decline in export earnings, however, will be more than offset by falling imports. Imports of goods and services are projected to fall by some $29.3 billion between 2008 and 2009—the first nominal decline in nearly a decade. The fall in imports reflects a combination of lower fuel and commodity prices, cooling domestic demand, and a decline in FDI and investment-related imports.

Figure 12.MEOIs: Current Account Balance

(In percent of GDP)

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

Tighter external financing

The improvement in the current account is expected to be broadly matched by a net decline in financing flows. The steady increase in central banks’ gross foreign reserves over the past eight years is projected to come to a halt—with reserves dropping slightly (in aggregate, a fall of about $2.8 billion between 2008 and 2009).

The MEOIs represent a range of economic structures and levels of development and depend on different types of foreign inflows (Box 4). Their integration with the world market through financial linkages ranges from relatively high (Egypt, Jordan, Lebanon, Pakistan—which rely on portfolio, direct investment, and remittance flows from the region and the rest of the world) to low in such cases as Afghanistan, which depend primarily on official development assistance (ODA). The relative weight and volatility of different kinds of financing flows have important implications for economic prospects in the MEOI group.

Portfolio and direct investment flows are subject to considerable volatility, particularly in the face of the current economic downturn, financial instability, and sharply diminished investor appetite. These flows also adjust quite rapidly, and the downside risk to these flows (based on end-2008 and early 2009 developments) has been incorporated into the current projections for MEOI countries. Potential changes in remittances and ODA are likely to emerge more slowly, but remain subject to downside risk as the historical stability of these flows comes under pressure in the face of an unprecedented global recession.

Some MEOIs have significant amounts of external debt, and the credit crunch is making it harder for them to access capital markets and to roll over their debt. While Lebanon, for example, successfully executed a Eurobond exchange in March 2009, it had earlier delayed a Eurobond issue and the privatization of the two mobile phone companies, in part owing to tight international capital market conditions. Moreover, deposit flows, a key source of government financing, are likely to slow in 2009. Egypt has seen a sharp decline in nonresident holdings of government debt, and a major recovery is not expected in 2009.

Downside risks on the horizon

Although the degree of vulnerability varies across countries, key near-term risks shared across the group include the following:

  • a deeper economic slowdown, which could have an impact on social stability and poverty;

  • risks from further reductions in external financing—from significant portfolio outflows, a further reduction in FDI inflows, lower-than-anticipated remittances, or cuts in official financing; and

  • the vulnerability of corporate and bank balance sheets to the negative impact of a deeper, longer global recession.

How should policies respond?

In short, the main challenge facing all MEOIs is how best to weather the ongoing storm, and how to position macroeconomic policies in an increasingly uncertain future. These countries have collectively faced a number of similar challenges in the past—sometimes related to economic cycles and crises, and at other times stemming from geopolitical concerns. But the unprecedented combination of both a global recession and a world financial crisis poses a broader set of policy challenges than in the past. So far, countries have responded with a range of fiscal and monetary policies (Table 5), but they face constraints.

Table 5.Middle Eastern Oil Importers: Summary of Crisis Response Measures
CountryMonetary easingDeposit guaranteesLiquidity/prudentialFiscal stimulusStock market intervention
Afghanistan
Djibouti
EgyptReiterated
Jordan
Lebanon
Mauritania
MoroccoAlready exists
Pakistan
Syria
Tunisia
Source: Data provided by country authorities.
Source: Data provided by country authorities.

Limited scope for countercyclical fiscal policy

The overall fiscal position for the MEOIs is projected to improve slightly in 2009—with the average fiscal deficit set to decrease from 5.8 percent of GDP in 2008 to 5.5 percent in 2009. Comparatively high levels of public debt (64 percent of GDP, compared with 16 percent in the MEOEs, and 15 percent in the CCA) put tight boundaries on any countercyclical fiscal policy. The net result is likely to be a “pause” in the recent trend toward debt reduction in these countries as fiscal consolidation is postponed. Such a pause likely represents the best middle ground in the current circumstances.

Box 4.How Important Are Different Forms of Foreign Inflows to Middle Eastern Oil Importers?

MEOI countries depend to varying degrees on a wide range of foreign financing, reflecting their different economic structures and levels of development.

Portfolio flows: The majority of MEOI countries have in the past tended to see net portfolio outflows—reflecting their relatively underdeveloped financial systems and, in many cases, lack of domestic capital markets. Within this group, however, for a key set of countries (Egypt, Lebanon, Pakistan and, to a lesser extent, Jordan) portfolio inflows have come to be an increasingly important source of financing. Net portfolio investment in the MEOIs as a whole rose from roughly $300 million in 2004 to some $8.1 billion in 2007, dominated by Egypt, Pakistan, Jordan, and Lebanon. Portfolio flows shifted into net disinvestment of $900 million in 2008, however, and are projected to fall further to a net outflow of $14.3 billion in 2009.

Foreign Direct Investment (FDI): Rising levels of liquidity in the region and improvements in the investment environment among the MEOIs prompted a surge in FDI during the past five years. Total FDI inflows for the group rose from some $9.3 billion in 2003 to an estimated $31.6 billion in 2008. The surge in foreign investment has been particularly marked in Djibouti, Egypt, Jordan, Pakistan, Syria, and Tunisia. While projections suggest that a few countries may be able to maintain current levels of FDI inflows (particularly in cases where investment is linked to large infrastructure projects), most of the MEOIs—particularly some of the star performers of recent years—are likely to see sharp declines in the wake of tighter international credit conditions, lower regional liquidity, and diminished investor appetite. Overall, FDI in the MEOIs is expected to fall by about $11 billion between 2008 and 2009.

Worker remittances: Remittances from expatriate workers are a significant source of income for the MEOIs—roughly on par with FDI at $31 billion in 2008. In nominal terms, these inflows are highest in Egypt, Morocco, and Pakistan, but as a share of GDP are most prominent in Jordan (14 percent), Lebanon (20 percent), and Morocco (8 percent). Gross remittances are projected to fall only marginally, from $31 billion in 2008 to $29 billion in 2009. This relatively small decline compared with portfolio and direct investment flows stems in part from the outlook for a fiscal stimulus in the GCC and other regions, but also because of the historical resilience of these flows. Nonetheless, the size of these flows and their role in supporting family incomes and the overall balance of payments in key countries highlight them as a source of potential risk—particularly if their long-standing constancy is tested by the current crisis.

Official Development Assistance (ODA): For most of the MEOI group, ODA (in the form of grants or concessional loans to the budget) plays a relatively minor role—totaling only about $4.6 billion in 2008. For a subset of countries (in particular, Afghanistan, Djibouti, and Jordan) these official flows play an important role in financing general budget operations. Like remittances, these flows are anticipated to be relatively stable, even in the face of recession in the major donor countries. Total flows to the MEOIs are projected to remain broadly unchanged in 2009.

The fiscal response in each of the MEOIs depends in part on the initial fiscal position (Figure 13). Some countries in the group witnessed an expansion of the fiscal deficit in 2008 owing to higher food and fuel costs, drought relief, or security-related expenditures—leaving little room for additional expansion in 2009. Some countries (including Morocco, Syria, and Tunisia) are approaching 2009 from a comparatively stronger fiscal position, owing either to government policies and/or additional fiscal space created by changing terms of trade. Even here, however, the scope for additional fiscal stimulus is likely to be limited, given the uncertainty of future prospects and a desire to hold on to progress made in the recent past on public debt reduction.

Figure 13.MEOIs: Government Fiscal Balance

(In percent of GDP)

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

Opportunities nevertheless exist for fiscal reform to better target social protection and make room for public investments. Several countries have already taken measures along these lines.

  • In Jordan and Syria, for example, fuel and commodity subsidies have either been eliminated or subjected to the first round of a phased reduction—a measure that in the short run will reduce pressures on fiscal balance and in the medium and long terms could create additional fiscal space for pro-poor and development expenditures.

  • In Pakistan, the government has committed to comprehensive tax reform and a phaseout of electricity subsidies to create fiscal space for public investment and social spending.

  • In other countries (such as Morocco) the additional fiscal room emerging in the wake of falling commodity prices is being used to boost capital expenditures and support wage increases at the bottom of the salary scale.

  • Egypt is also expanding capital expenditures, partly through a higher fiscal deficit, but also because of higher-than-budgeted revenues.

Some countries in the group fare poorly with respect to the level of overall tax revenue (Table 6), and tighter fiscal constraints should strengthen the incentive for improvements to both tax policy and administration.

Table 6.Tax Revenue(In percent of GDP)
Average

2004-08
Afghanistan4.8
Djibouti20.2
Egypt14.9
Jordan19.6
Lebanon15.3
Mauritania14.6
Morocco23.3
Pakistan10.6
Syria14.1
Tunisia21.2
Sources: World Economic Outlook; and IMF staff estimates.
Sources: World Economic Outlook; and IMF staff estimates.

The rapidly changing international economic landscape has put a premium on flexibility in policy making and enhanced the need for fiscal adjustment—particularly in countries with acute fiscal pressures and/or with heavy rollover requirements. Additional expenditure cuts and revenue reforms should be identified in the event that fiscal pressures do not abate. Particularly for those countries with a dependence on external financing and high rollover requirements, or where market conditions have delayed privatization plans, plans to deal with shortfalls are essential, including financial support from multilateral agencies. Pakistan, for example, is seeking to tap nonbank sources of domestic financing, and has also prepared contingency plans to rationalize development spending in the event that fiscal pressures intensify.

Social considerations may limit the pace and scope of fiscal consolidation among the low-income countries in the group. In particular, for those countries with low per capita income and a high incidence of poverty (Djibouti and Pakistan), recourse to official financing to alleviate short-term fiscal and balance of payments pressures may become increasingly necessary as the global recession deepens.

Some room for monetary easing

Monetary policy among the MEOIs has been largely dictated by the prevalence of fixed exchange rate regimes. Within this constraint, MEOI central banks generally raised policy interest rates during the first half of 2008, followed by a partial reversal in the latter half of the year and in early 2009 as commodity/import prices eased.

Some countries have taken steps to ease monetary policy in the wake of the fall in international commodity prices and associated declines in domestic inflation. Tunisia reduced reserve requirements by 250 bps to 7.5 percent in January 2009 and also lowered its key policy interest rate from 5.25 percent to 4.5 percent in February 2009. Jordan lowered policy interest rates by 150 bps in three steps during late 2008 and early 2009, and similarly reduced reserve requirements by 300 bps to 7 percent (reversing a 200 bps increase earlier in 2008). Morocco also lowered reserve requirements from 15 percent to 12 percent in January 2009 to address declining liquidity, and lowered its key policy interest rate by 25 bps in March 2009. Egypt has lowered overnight interest rates by 150 bps in two steps since February 2009 in light of lower inflation and the need to support growth.

Looking forward, the preference for exchange rate stability and the need to maintain sufficient capital inflows may limit the extent to which many of the MEOIs can ease monetary policy further to support investment and growth. Caution is warranted given an uncertain economic environment—particularly with regard to trade and balance of payments developments, and the potential for further declines in capital inflows. However, assuming international prices remain soft and balance of payments pressures do not intensify, there should be room for selective monetary easing, especially in view of low international rates. In countries that have flexible exchange rate regimes, greater exchange rate flexibility will aid in adjusting to the effects of the global crisis.

Enhance financial supervision and contingency planning

Financial sector policies and adequate supervision will remain key in the period ahead. While the first-round effects of the global crisis on the MEOI financial sectors have been limited, the projected decline in economic growth is likely to eventually put pressure on banks’ balance sheets via lower profits and more nonperforming loans.

Financial sector risks have not gone unnoticed in the MEOIs. Blanket deposit guarantees are in place in Egypt and Jordan. Pakistan has prepared a contingency plan for handling problem banks, and is encouraging such banks to proceed with mergers or fresh capital injections. Lebanon has stepped up reporting requirements on domestic and foreign operations, intensified on-site inspections, and prepared draft legislation for the creation of a financial market regulatory authority. Authorities in Jordan have heightened supervision, and are encouraging increases in bank capital. Closer supervision and analysis of potential risks is also evident in Morocco, Syria, and other countries.

In addition to tighter supervision, contingency plans for dealing with bad or troubled banks should be developed. Where not already in place, prompt corrective action frameworks should be established to set the rules for government intervention and coordination across agencies. Contingency plans to handle the potential fiscal costs of such operations should also be developed.

Note: This chapter was prepared by Domenico Fanizza, Todd Schneider, and Harald Finger, with research support from Hirut Wolde.

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