Annex 2. International Linkages and Spillovers for MENAP and CCA

International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
November 2013
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MENAP and CCA economies’ international linkages have been strengthening during the past decade; yet both regions remain only moderately integrated into the global trade and financial system. As a result, output cycles in the region are only partially synchronized with global developments, and the impact of global shocks on the region is limited. A slowdown in major emerging market economies would somewhat weaken growth in MENAP and CCA because of lower commodity prices, as well as exports and remittances, particularly from Russia. The effects of slower growth in the euro area would be felt mostly in the Maghreb, given its strong export and remittances links with Europe. Low external financial exposures and financial development limit the potential impact of a greater and longer-lasting tightening of global financial conditions on the region. Pockets of vulnerabilities nonetheless exist, particularly in countries with large financing needs, low external and financial buffers, or both.

Moderate Yet Growing Linkages to the Rest of the World

Greater openness has contributed to higher synchrony with global developments. In line with globalization trends and rising hydrocarbon prices, exports-to-GDP ratios have risen in oil exporters since the early 1990s. The increase in openness in oil importers has been smaller, owing to difficulties in gaining market share in highly competitive global markets (Table A2.1). However, the role of remittances flows in the oil-importing economies has increased, especially in the CCA and in some MENAP oil importers, as these countries have increasingly exported labor to faster-growing and richer nations. Foreign direct investment (FDI) as a share of GDP has increased, more in the CCA than in MENA. External bank exposures, as measured by liabilities to foreign banks, are moderate in MENAP and low in the CCA, with sources of funding concentrated in Europe. Banking exposures have risen in a number of countries, however, especially in Qatar and Saudi Arabia, where they now surpass their pre-global-crisis peaks (Figure A2.1).

Table A2.1.Openness Has Increased(Exports, remittances, and foreign direct investment; percent of GDP)
ExportsRemittance InflowsForeign Direct Investment
CCA exporters3748n.a.
CCA importers34321.412.73.67.0
MENAP exporters37530.
MENAP importers23283.
Sources: National authorities; and IMF staff estimates.Note: n.a. = not available.
Sources: National authorities; and IMF staff estimates.Note: n.a. = not available.

Figure A2.1Lending by Foreign Banks to Selected Emerging Market Regions

(Data as of March 2013; percent of recipient’s GDP)

Source: Bank for International Settlements.

Note: LAC = Latin America and the Caribbean; SSA = Sub-Saharan Africa.

1 Excludes Australia, Japan, and New Zealand.

Bilateral (non-oil) export and remittances links remain strong with Europe and Russia, and are rising with China. Because of the Maghreb countries’ proximity to Europe, about three-quarters of their non-oil export and remittance receipts come from the continent. Europe is a less important trading partner for the Mashreq countries because of their close linkages with the GCC through both trade and remittances flows. The share of non-oil exports to China from many MENAP and CCA countries has increased during the past decade, largely reflecting China’s rapid growth (Figure A2.2). Russia remains the dominant source of remittances to the CCA (Figure A2.3).

Figure A2.2Share of Non-Oil Exports by Destination

(Percent, period averages)

Source: UN, Comtrade; and IMF staff calculations.

Figure A2.3Shares of Remittances Inflows by Remitting Region


Sources: World Bank; and IMF staff calculations.

Multicountry networks increase exposures to major advanced and emerging market economies. For example, the CCA countries’ exposures to Europe are amplified by their strong links to Russia’s economy, which, in turn, is closely linked to Europe’s. MENAP and CCA exposures to the United States are augmented by exports to China and hence the Asian supply chain, for which the United States is an important market. Correlations with Turkey may reflect shared exposures to other countries in addition to bilateral linkages.

Notwithstanding growing non-oil trade and remittances, oil prices remain an essential channel linking the region to the global economy. Because the world’s major advanced and emerging market economies account for a large portion of global oil demand, developments in these economies determine changes in global oil prices and, consequently, growth in MENAP and CCA oil exporters. Oil prices also matter for Russia’s economy, which means that strong correlations between the MENAP oil exporters and Russia largely reflect common global exposures rather than spillovers. For the oil importers, the net effect of oil price changes on the economy is ambiguous. An increase in oil prices, for example, tends to weaken their terms of trade, reduce disposable incomes, and raise business costs. At the same time, higher oil prices lead to higher external demand from the oil-exporting neighbors, including for tourism and other exports, as well as larger workers’ remittances. These offsetting effects are particularly important for oil importers in the Mashreq.

Increasing Synchrony of Output Cycles

Reflecting evolving bilateral and multicountry linkages, output comovements of MENAP and CCA with other economies are moderate but rising (Figure A2.4).1

Figure A2.4Moderate but Increasing Synchrony

(Correlations of GDP, 1993–2002 and 2003–12)

Sources: National authorities; and IMF staff calculations

Note: Correlations are calculated for each country using annual GDP data for 1993–2002 and 2003–12, and a simple average is taken to represent subregions.

  • The output cycles of the MENAP and CCA economies are only moderately synchronized with those in advanced and emerging market economies. Economic growth in MENAP oil exporters is moderately correlated with growth in the United States, the euro area, and emerging markets, mainly reflecting linkages via global oil demand and prices. Similarly moderate and broad-based output correlations are observed for the CCA countries. For the MENAP oil importers, correlations with output growth in most other countries are low, suggesting that economic growth in this subregion tends to be driven by domestic factors.

  • Comovement of output cycles in the MENAP and CCA economies with the rest of the world, particularly with China, has strengthened over the past decade. Increases in output correlations of MENAP and CCA countries with China have been larger than those with other advanced and emerging market economies, in some cases becoming positive where they had previously been negative. Output correlations between the CCA oil exporters and Russia weakened during the past decade, reflecting, in part, a reorientation of their trade from Russia to other trading partners, particularly China. By contrast, the CCA oil importers maintained strong links with Russia, especially through continued exports of labor to Russia and the associated remittances inflows.

To evaluate spillovers, the impacts of three global downside scenarios are studied.2 The outlook for the region is subject to a number of external risks, including a sharp slowdown in major emerging market economies or the euro area, and a rise in global interest rates as the United States exits from very accommodative monetary policy. To distinguish between correlations and actual spillovers, the analysis estimates the impacts of shocks in these three cases.

Lower-than-Anticipated Growth in Emerging Markets Is an Important Risk

A sharp slowdown in major emerging market economies would have a large impact on global GDP and oil prices (Figure A2.5). Private investment in the BRICS (Brazil, Russia, India, China, South Africa) has repeatedly surprised on the downside in recent years. If investment in these countries falls 10 percent below the forecast in 2014, a decline in the BRICS’ external demand accompanied by capital outflows from emerging markets would reduce global GDP by 1¾ percent and oil prices by almost 20 percent on impact (see the April 2013 World Economic Outlook).

Figure A2.5GDP Impact of Emerging Market Slowdown

(First year, percent change relative to baseline)

Sources: National authorities; and IMF staff calculations.

The oil exporters would share in the adverse consequences of a fall in hydrocarbon prices. Some countries would have to scale back oil output as they did during the global financial crisis. Most oil exporters have buffers with which to conduct countercyclical fiscal policy, which would limit the GDP impact to about 1 percent in the first year. The GDP impact would be higher in the CCA exporters than in the MENAP exporters because of the CCA’s stronger non-oil export linkages to the BRICS, particularly to Russia, resulting in non-oil exports falling 4 percent. However, fiscal balances would be more severely affected in MENAP than in CCA because of higher fiscal breakeven oil prices (see Chapters 1 and 3).

The oil importers would experience lower exports and remittances. For the CCA oil importers, these spillovers would be mostly from Russia and, to a lesser extent, China, whereas for the MENAP oil importers, the indirect impact through the induced slowdown in Europe would match the direct effects of a slowdown in emerging market economies. For example, CCA importers’ non-oil exports would fall 4½ percent, of which more than two-thirds would be directly through the BRICS. For the MENAP oil importers, a reduction in non-oil exports of 3 percent would be roughly equally attributable to Europe, the BRICS, and the rest of the world. Some countries would be able to ease monetary policy and allow automatic stabilizers to operate; however, the scope for countercyclical policy would be generally limited given large fiscal deficits, high inflation, and rigid exchange rate regimes. The overall GDP loss in the MENAP and CCA oil importers is expected to be about ½ percent. In a number of countries, a slowdown in growth would heighten concerns about fiscal and external sustainability, leading to a vicious cycle of declines in confidence and economic activity.

Slowdown in the Euro Area Would Mainly Affect the Maghreb

Waning confidence, reduced investment, and increased concerns about fiscal sustainability could lead to persistently slower growth in Europe. The decline in confidence might reflect slow progress in repairing balance sheets and implementing the needed structural reforms. It would lead to rising risk premiums and additional fiscal tightening, further weakening the macro environment and confidence, and reducing private investment. Euro area growth would fall by ½ percent per year over five years. Global GDP would be mildly but persistently affected, and oil prices would fall by about 1 percent per year (see the April 2013 World Economic Outlook).

A growth slowdown in Europe would primarily affect the Maghreb countries because of their close trade and remittances links (Figure A2.6). The impact on MENAP and CCA countries would be persistent but small in aggregate (about one-tenth of a percent in the first year). However, export and remittances losses of about 1 percent could make the GDP loss as large in the Maghreb (½ percent in the first year) as in Europe. The impact on the CCA oil importers would be smaller because they have more diversified patterns of trade, although CCA oil exporters would also feel the impact indirectly through Russia. To the extent that a slowdown in growth leads to further deleveraging by European banks, MENAP and CCA borrowers would be affected. However, the impact would generally not be expected to be large, because European banks in the MENAP and CCA regions often operate through subsidiaries that are primarily funded by local deposits.

Figure A2.6GDP Impact of Euro Area Slowdown

(First year, percent change relative to baseline)

Sources: National authorities; and IMF staff calculations.

Effects of Tighter Global Financial Conditions Should Be Manageable

A faster-than-expected recovery in the United States would lead to higher global interest rates. If a recovery starting in 2014 results in the United States growing more quickly than in the IMF World Economic Outlook baseline, monetary policy would tighten earlier and by more than expected. The policy rate could rise 50 basis points above baseline expectations in 2014 and peak at 150 basis points above baseline in 2016 (IMF, 2013f). Global uncertainty surrounding U.S. monetary policy could increase international yields and risk premiums. The resulting tightening of financial conditions would reduce domestic demand across the world, offsetting the positive effects from stronger U.S. import demand, so oil prices would be likely to rise by only about 2 percent.

External and domestic demand in most MENAP and CCA countries would not be materially affected (Figure A2.7). Effects via oil prices and trading partner growth would be small. Export and remittance receipts of the CCA and Maghreb countries would decline slightly because Russia and Europe would experience a small slowdown in growth. Domestic interest rates in countries with U.S. dollar pegs would rise in tandem with U.S. rates, weighing on investment and growth, but the transmission of policy rates to private sector activity would be limited in many countries, particularly in the GCC, because of caps on lending rates and structural excess liquidity on bank balance sheets. However, some public capital expenditure plans would become more expensive to finance and would need to be scaled back, while countries with high public debt might need to tighten their fiscal positions, which would soften domestic demand.

Figure A2.7GDP Impact of U.S. Growth and Monetary Tightening

(First year, percent change relative to baseline)

Sources: National authorities; and IMF staff calculations.

A rise in the cost of funding should also have a limited effect on the region, because financing needs are generally low or are met by relatively stable sources. The effect of higher global interest rates on MENAP oil exporters would be mostly felt through a decline in the book value of their sovereign wealth portfolios. Financing needs of MENAP oil exporters are generally small (Figure A2.8), given their large external and fiscal surpluses, although Dubai and Bahrain would need to roll over debts at a higher cost in the coming years (see Chapter 1). Oil importers have large external and fiscal financing needs, but they are met mostly by external official flows at concessional rates, nonresident deposits, or through sales of local bonds to domestic banks (see Chapter 2). Foreign participation in local bond markets is small (Figure A2.9); rollover risks are thus limited. Those risks may become an issue if, for example, FDI were to dry up; otherwise domestic banks would need to sharply step up their purchases of government bonds to substitute for declining external financing. For a discussion of the likely effects on the CCA, see Chapter 3.

Figure A2.8Gross External Financing Needs in 20131

(Percent of GDP)

Sources: National authorities; and IMF staff calculations.

1 Calculated as the sum of current account deficit (excluding official current transfers) and amortization scheduled, with a floor of zero.

2 Excludes nonresident deposits.

Figure A2.9MCD: International Issuance of Bonds, Equity, and Loans

(Percent of GDP)

Sources: Dealogic; national authorities; and IMF staff calculations.

In most countries, financial sectors should be able to withstand moderate shocks. Banks are generally healthy and have limited external exposures. International bank lending to MENAP firms and banks has been rising but remains below the emerging market average, except for Morocco, Qatar, and the United Arab Emirates. Lending by global banks to the CCA is small (less than 10 percent of GDP), as Kazakhstani banks have reduced their exposure to wholesale funding since the global financial crisis. Firms in MENAP and CCA generally rely on domestic sources of funding, mostly through banks, which finance themselves largely through local deposits.

Nonetheless, pockets of financial vulnerability exist. Some banking systems have loan-to-deposit ratios exceeding 100 percent, and some banks with large external wholesale financing needs might be vulnerable (Figure A2.10). Capital buffers are typically above emerging market averages (Figure A2.11); although, in some cases, capital positions could prove vulnerable in light of relatively low provisioning (Jordan, Tunisia), while nonperforming loans are high in others. Kuwait’s investment companies could be exposed to funding and asset valuation risks (see Chapter 1).

Figure A2.10MENAP and CCA Banking System: Loan-to-Deposit Ratios

(2008–June 2013, or latest available month)

Sources: National authorities; and IMF staff calculations.

Note: Em. Eur. = emerging Europe.

Figure A2.11Capital Adequacy Ratios

(Percent of risk-weighted assets, 2012 or latest available data)

Sources: National authorities; Global Financial Stability Report, April 2013; and IMF staff estimates.

Note: EM = emerging market.

Significant protracted economic and financial market volatility, especially in emerging markets, would affect MENAP and CCA. In the event of a sudden stop of capital flows to emerging markets and a severe loss of liquidity, global economic activity is likely to slow down. Economic activity in the region is likely to weaken because of lower oil prices, lower production, or both, as well as declining non-oil exports to the affected trading partner countries. Remittances inflows, which generally tend to be more resilient than exports of goods and services, may also moderate. In addition, as shown by the recent episode of increased financial market volatility and capital outflows from emerging markets in May and June 2013, bond yields for countries in the region generally rise in tandem with those in emerging markets (Figure A2.12).3 The effects on bond yields for most MENAP oil importers tend to be smaller than those in MENAP oil exporters and CCA because country-specific and regional factors are the main determinants of risk premiums in this subgroup (see Chapter 2).

Figure A2.12Bond Yields

(Percent, September 1, 2012–September 10, 2013)

Source: Bloomberg, L.P.

For a discussion of output correlations in other regions as well as within the MENA and CCA countries, see Chapter 3 of the October 2013 World Economic Outlook. Country-specific correlation analysis can be found in reports for Armenia (“Republic of Armenia, Article IV Consultation,” IMF Country Report No. 13/34 [Washington, 2013]) and Jordan (“Jordan: 2010 Article IV—Staff Report and Public Information Notice,” IMF Country Report No. 10/297 [Washington, 2010]).

Quantitative results are based on two global macroeconomic models used in the World Economic Outlook and developed by Cashin, Mohaddes, and Raissi (2012), as well as trade simulations in Behar and Espinosa-Bowen (forthcoming) and remittances analysis in Abdih and others (2012). For an application to an individual country, see “United Arab Emirates: Selected Issues,” IMF Country Report No. 13/240 (Washington, 2013).

A steeper increase in the CCA than in other regions was partly explained by the concurrent announcement by the Azeri state oil company of an ambitious new investment strategy.

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