The financial turmoil that erupted in August 2007 and developed into possibly the worst financial shock since the end of World War II has slowed the global expansion. Economic activity in advanced economies decelerated sharply toward the end of the year as the crisis in the U.S. subprime mortgage market spread across a range of financial institutions and markets. The weakening of growth was most pronounced in the United States. Emerging market and developing countries have thus far been less affected and continue to grow at a rapid pace, owing to positive terms of trade movements from the increase in oil and commodity prices, strong productivity gains resulting from greater integration into the global economy, and improved policy frameworks that have underpinned sustained access to capital. Headline inflation has increased around the world, fueled by high oil and commodity prices; in many developing and emerging market countries, more generalized inflationary pressures are being sustained by strong growth in domestic demand (Figure 17).

Economic Outlook

World economic outlook7

The financial turmoil that erupted in August 2007 and developed into possibly the worst financial shock since the end of World War II has slowed the global expansion. Economic activity in advanced economies decelerated sharply toward the end of the year as the crisis in the U.S. subprime mortgage market spread across a range of financial institutions and markets. The weakening of growth was most pronounced in the United States. Emerging market and developing countries have thus far been less affected and continue to grow at a rapid pace, owing to positive terms of trade movements from the increase in oil and commodity prices, strong productivity gains resulting from greater integration into the global economy, and improved policy frameworks that have underpinned sustained access to capital. Headline inflation has increased around the world, fueled by high oil and commodity prices; in many developing and emerging market countries, more generalized inflationary pressures are being sustained by strong growth in domestic demand (Figure 17).

Figure 17.
Figure 17.

Global Outlook

(Annual change; in percent; unless otherwise indicated)

Source: IMF, World Economic Outlook.

Food and energy prices soared in 2007 on account of strong demand amid tight supply conditions (Figures 17 and 18). Beyond temporary factors such as speculation and weather-related production shutdowns, the sharp increase in oil prices in 2007 was due to sustained oil market tightness (Box 7). The latter reflects the slow adjustment to higher demand from emerging markets, with global demand being relatively price inelastic in the short run and global capacity responding very slowly.8 The increase in food prices, particularly of grains and edible oils, reflected strong growth of per capita income in developing countries, rising biofuel production, and tight supply conditions.

Figure 18.
Figure 18.

International Commodity Prices

(Index, 2000 = 100)

Source: IMF, World Economic Outlook.

Looking forward, oil markets are expected to remain tight through 2008, with oil prices averaging about US$95 a barrel (Figure 19). While non-OPEC supply should increase slightly, OPEC seems unlikely to raise production given the prospects of lower growth in advanced economies. Global demand is expected to continue to rise at a moderate pace. The near-term balance of risk to oil prices is on the upside, as prices remain sensitive to tight supply and geopolitical uncertainty. In this regard, Saudi Arabia’s continued constructive role will be vital for global oil market stability.

Figure 19.
Figure 19.

Brent Crude Oil Prices

(In U.S. dollars a barrel)

Source: IMF, World Economic Outlook.Note: Projections based on futures markets.

Its planned investments are US$80 billion over the medium term, with a view to expanding production capacity in the oil sector by 37 percent to 12.5 mbd and refining capacity by 43 percent to about 6 mbd. A further US$170 billion in oil investment is planned by the other GCC countries. Similarly, food prices are expected to peak in 2008 but ease gradually thereafter. But here too, the balance of risk is tilted to the upside because of the diversion of agriculture toward biofuel production and strong demand from developing countries.

Global growth is projected to moderate to 3.7 percent in 2008 from 4.9 percent in 2007 and remain broadly unchanged in 2009 (Figure 20). This is predicated on commodity prices remaining roughly at their end-2007 levels and on conditions in the financial markets stabilizing only gradually during 2008, maintaining risk spreads substantially wider than those that prevailed before August 2007. Growth in advanced economies is projected to fall from 2.7 percent in 2007 to 1.3 percent in 2008, with the United States moving into a mild recession. Growth in emerging markets and developing countries is projected to slow to 6.7 percent from 7.9 percent in 2007, reflecting efforts to prevent overheating in some countries as well as trade spillovers and some moderation in commodity prices. Inflation is expected to remain high in the first half of 2008, but should decline gradually thereafter, as commodity prices stabilize and slack in some countries emerges.

Figure 20.
Figure 20.

Global Growth Forecast

(In percent)

Source: IMF, World Economic Outlook.

Oil Prices: Fundamentals or Speculation?

Oil prices have continued to break records in 2008 (at over US$100 a barrel, and reaching a historical high of US$119 a barrel on April 22), even while it is widely believed that the U.S. economy is sliding into recession. At these levels, are oil prices being driven by fundamentals or by speculation?

Since 1970 there have been five global recessions (with world economic growth falling to about 2½ percent a year or less). The first two (1974–75 and 1980–82) were associated with large prior hikes in oil prices (reflecting supply shocks). As Figure B7.1 shows, real oil prices did not immediately fall when the recessions began.1 Oil prices remained quite firm one year into each of the recessions, and did not fall significantly until world economic growth had clearly recovered. By contrast, the following three recessions (1991–93, 1998, and 2001) were associated with declines in real oil prices at the outset (although these declines were not particularly large). Why the difference? It is possible that the Organization of Petroleum Exporting Countries (OPEC) had greater market control in the 1970s than it did during the 1990s. As a result, it was easier to prevent falls in oil prices (as demand weakened) in the 1970s than it was in the 1990s.

This observed pattern suggests that it would take a global recession to bring about a major decline in oil prices. Currently, the IMF is projecting a decline in world growth to 3.7 percent, which means that oil prices should not be expected to fall sharply if they are being driven solely by economic growth (“fundamentals”). Even if the world does go into a recession, history suggests that the effect on oil prices could be lagged, depending on how much discipline OPEC is able to exert.

It is hard to explain current oil prices in terms of fundamentals alone. The recent surge in the oil price (from US$80 to over US$100 a barrel) seems to go well beyond what would be indicated by the growth of the world economy. Producers and many analysts say it is speculative activity that is pushing up oil prices now. Producers in particular argue that fundamentals would yield an oil price of about US$80 a barrel, with the rest being the result of speculative activity.

It is difficult to get a direct measure of speculative activity. It is true that open positions in oil futures more than doubled in size over 2003–07. Net long noncommercial positions at the New York Mercantile Exchange briefly reached new highs in mid-2007, after which they declined. Yet prices have stayed high even as these speculative positions were unwound. Moreover, there is evidence that changes in net long noncommercial positions generally follow price changes rather than lead them. So this line of reasoning would imply that speculation is not the cause of recent increases in oil prices.2

Figure B7.1.
Figure B7.1.

Real Oil Prices and World Growth

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

Another way to get a sense of speculative activity is to compare movements in the real price of oil with the real price of gold. This relationship has been surprisingly close for a long period of time (Figure B7.2). Gold is well known to be a highly speculative commodity, driven by factors other than derived demand. One could reasonably argue that this relationship, which has continued in 2008, is evidence of speculative behavior in oil. If the oil price does fall significantly in the near term, it may reflect more the unwinding of speculative positions in both gold and oil than indicate that a recession is under way.

In summary, it appears that speculation has played a significant role in the run-up in oil prices as the U.S. dollar has weakened and investors have looked for a hedge in oil futures (and gold). As financial market conditions settle down, fundamentals should take over and oil prices should come down further from the highs recently observed. How far they will come down will depend on how the world economy is doing, and if history is to be a guide, they will come down slowly.

Figure B7.2.
Figure B7.2.

Oil and Gold Prices Deflated by U.S. CPI

(Base year = 2007)

Source: IMF, World Economic Outlook.

1 Real oil prices are defined as the nominal price deflated by the U.S. consumer price index (CPI).

2 It should be noted that the distinction between commercial and noncommercial positions in oil futures is difficult to make. Total positions may be a better indicator of speculative activity.

Risks to the baseline projection, however, are significantly to the downside, with the greatest risk coming from the still-unfolding events in financial markets and their potential impact on global activity. The recession in the United States could be more severe if the correction in housing prices and ensuing deterioration of households’ net worth are more pronounced.

There is also a risk that the credit crunch might intensify, as both engines of credit creation—the banking system and the securities markets—are being impaired at the same time. Similar housing price corrections in other countries in Europe, although likely to be less pronounced, could also weigh down global growth. Continued inflationary pressures also pose downside risks as they may constrain policymakers’ room for maneuver. Emerging market economies would be affected more substantially if the advanced economies were to experience a major downturn or if the rise in sovereign spreads and the retreat in equity markets were to intensify. Emerging markets that rely on short-term cross-border borrowing to finance large current account deficits are also more vulnerable to persistent turbulence in financial markets.

Outlook for the MCD region

The MCD region is expected to remain comparatively resilient to global uncertainty. The short-term outlook remains favorable and has changed little compared with the projections in the October 2007 Regional Economic Outlook: Middle East and Central Asia, notwithstanding the downward revision in global growth and the uncertainty about the scope and depth of the ongoing turmoil in financial markets.

  • In oil exporters, growth is expected to remain at about 6¼ percent, with a pickup in oil production compensating for a moderate slowdown in the non-oil sectors. Large investments made in previous years should support productivity gains and sustain high growth. In the GCC countries, given the comfortable foreign asset position, government-planned investment programs are likely to be maintained even if oil prices decline. But the global credit squeeze could affect the pace of project implementation. In Kazakhstan, the construction and real estate sectors are expected to be significantly affected by the decline in credit growth, with real GDP growth projected to ease to 5 percent in 2008 from 8.5 percent in 2007.

  • In low-income countries, growth is expected to moderate somewhat but would remain at about 7 percent. Improved policy frameworks, structural reforms, a pickup in private investment, and better public infrastructure are supporting high productivity gains, which could sustain growth in the 6–7 percent range over the medium term. In Djibouti, growth is expected to accelerate further, driven by the implementation of large FDI-financed projects and policies to ensure that growth is not confined to the enclave around the port. In Georgia, the tightening of fiscal and monetary policies, combined with less favorable global conditions and increased political uncertainty, could dampen growth somewhat, although it is still expected to remain at a very healthy 9 percent.

  • The short- and medium-term growth prospects of emerging market economies are favorable, provided governments continue to pursue fiscal consolidation and structural reforms to boost business confidence and improve the investment climate. Lebanon’s recovery should maintain momentum and a growth takeoff is likely once political tensions are resolved. Growth in Morocco should rebound as agricultural output recovers, and solid growth in Egypt, Pakistan, and Tunisia is expected to continue.

The inflationary pressures that have accompanied the economic expansion of the past few years are unlikely to abate. This applies particularly to Algeria and Libya, where the stance of fiscal policy is expected to remain expansionary. In oil-producing countries that peg their currencies to the U.S. dollar, past and prospective monetary easing could increase inflationary pressures, although the removal of supply bottlenecks might alleviate some of these pressures (notably in Kuwait, Qatar, and the U.A.E., where the completion of a large number of new housing units should slow the escalation of rental costs). Wages are meanwhile being bid upward by the weakening dollar, which is reducing the send-home value of expatriate pay, and improved labor market conditions in expatriates’ home countries. In countries where core inflation has so far been fairly stable but where headline inflation is being driven up by fuel and other commodity prices, there are concerns that second-round effects could start a wage-price spiral.

The MCD region’s fiscal surplus is expected to increase moderately in 2008, reversing the decline in 2007. This would be driven mainly by an increase in the fiscal surplus of oil-exporting countries to 13¾ percent of GDP from 11 percent in 2007, as the projected increase in oil revenues outweighs further widening of the non-oil budget deficit. In line with the policy plans adopted in the context of the 2007 multilateral consultation on global imbalances, Saudi Arabia is ramping up spending on much-needed social and economic infrastructure. IMF staff projections suggest that the 2008 budget outturn will be markedly more expansionary than in 2007, with the non-oil budget deficit projected to widen by 8 percentage points of non-oil GDP to over 60 percent. Low-income countries and emerging markets are expected to maintain prudent fiscal policies in 2008, except Tajikistan, where the sharp increase in budget appropriations is likely to lead to a widening of the budget deficit of 2 percentage points of GDP. Although debt-to-GDP ratios are still projected to decline, lower revenues and higher budget subsidies in Pakistan, and an acceleration in capital spending and civil service hiring in Morocco, could lead to a deterioration in their fiscal deficits. In the West Bank and Gaza, the necessary fiscal adjustment will require close cooperation and prompt action by all shareholders (Box 8).

Notwithstanding continued strength in import growth (20 percent in U.S. dollar terms), the expected further rise in oil prices will keep the region’s current account surplus at about 18¼ percent of GDP in 2008, leading to further accumulation of international reserves. For oil exporters, the current account surplus could rise to 24¼ percent of GDP, despite a substantial widening of non-oil current account deficits in Algeria, Kuwait, Libya, and Saudi Arabia. In emerging market economies, current account deficits are expected to remain at a comfortable level, except in Jordan and Lebanon, where large current account deficits are likely to persist, increasing their vulnerability to reversals in capital inflows. In the case of Pakistan, the current account deficit has increased significantly, owing to higher oil import prices and continued strong aggregate demand growth. In low-income countries the deficit is expected to narrow, mainly because of continued large surpluses in Uzbekistan and lower projected deficits in Georgia, Sudan, and Yemen.

Risks to the outlook are broadly neutral, with downside risks from the external sector balancing upside risks to domestic demand. High oil prices and additional cuts in U.S. interest rates could stimulate further domestic demand and higher inflation in the GCC countries. Also, the rising surpluses of oil-producing countries, combined with concerns about asset quality in advanced economies, may well translate into increased inflow to the other countries in the region, fueling credit growth and domestic demand. However, a protracted slowdown in advanced economies would have a negative impact on growth in most MCD countries, as it could lead to a more substantial drop in oil prices and lower exports. The tightening of credit conditions in advanced economies may curtail the capital inflows that have supported growth in many countries in the region. A continued rise in inflation is another risk to the outlook.

West Bank and Gaza: The Road to Recovery

Sustained economic recovery and fiscal adjustment will require close cooperation and prompt actions by the Palestinian Authority (PA), the government of Israel, and the donor community.

The West Bank and Gaza has faced enormous economic, political, and social challenges in recent decades. The past two years have been especially difficult.

The financial sanctions imposed by many donors following the election of the Hamas-led government, together with internal turmoil, precipitated a liquidity crisis for the PA and depressed an already weak economy. Real GDP contracted by almost 5 percent in 2006, and continued on a downward path in the first half of 2007 (Figure B8.1).

Following the formation of the government led by Prime Minister Salam Fayyad in June 2007, international financial sanctions were eased, and the Israeli government resumed the transfer of the indirect taxes (“clearance revenue”) it collects on behalf of the PA. However, Israel’s tight control over Gaza’s borders since June 2007 led to a significant decline in private sector activity there. Taking into account the negative impact of Gaza’s isolation on the overall economy, real GDP growth for the West Bank and Gaza together is estimated to be zero for 2007.

Since mid-2007 the PA has initiated important measures to reduce the budget deficit estimated at an unsustainable 27 percent of GDP in 2007 (Figure B8.2). These included tight controls on new public employment and steps to reduce utility subsidies. Public expenditure management also improved as cash controls were restored to their pre-2006 levels, allowing the PA to effectively manage donor support through the Single Treasury Account.

The Palestinian Reform and Development Plan (PRDP) for 2008–10 envisages further steps toward fiscal sustainability, good governance, and security reforms. The framework is based on three key assumptions:

Figure B8.1.
Figure B8.1.

Real GDP Growth

(Annual change; in percent)

Sources: Data provided by country authorities; and IMF staff estimates and projections.
Figure B8.2.
Figure B8.2.

Fiscal Indicators

(In percent of GDP)

Sources: Data provided by country authorities; and IMF staff estimates and projections.
  • an improved trade environment as a result of a gradual relaxation of Israeli restrictions on movement of goods and people;

  • a sustained reduction in the PA’s budget deficit, supported by an expansion of private sector activity; and

  • scaled-up donor assistance to cover both the recurrent budget deficit and higher public investment, facilitated by the relaxation of trade restrictions, and combined with steady fiscal consolidation.

With the above assumptions and policy expectations, real GDP growth is projected to rise from zero in 2007 to 3 percent in 2008 and to 6½ percent by 2010. The increase in donor-funded and private sector investments would gradually offset the impact of fiscal consolidation and help lay the foundations for longer-run sustainable growth.

Given this macroeconomic outlook, the recurrent budget deficit would decline from 27 percent of GDP in 2007 to under 16 percent by 2010 on the basis of (1) strict containment of the wage bill; (2) a reduction in net lending through measures to improve the incentives for municipalities and households to pay their utility bills; and (3) a strengthened cash management and commitment control system to allow higher-quality spending and better prioritization to help prevent arrears accumulation.

A number of structural reforms are also planned for the next three years: notably, (1) full-fledged civil service reform; (2) an efficient social safety net to target assistance to the truly needy; (3) reforms in the electricity sector and municipalities’ public finances; and (4) a comprehensive reform of the public pension system to restore its viability.

The planned fiscal adjustment is ambitious but achievable. It will be politically very difficult, and feasible only if Israel is willing to substantially reduce its restrictions on movement and access. The continuing isolation of Gaza is a particular concern, as this could slow public investment and reforms.

The PRDP received broad support at the Paris International Donors’ Conference held in December 2007. Donors pledged US$7.4 billion, significantly above the US$5.6 billion required under the authorities’ fiscal plan. While it is difficult at this point to determine the precise mix of project and budget financing that has been pledged, a reallocation might be required to fully meet the current budget’s financing needs. The conference’s results provided a strong signal of political and financial support for the PA’s vision of a Palestinian state.

Policy Challenges

Almost all countries in the region experienced a rise in inflation during 2007. The most immediate challenge for these countries is, therefore, to bring inflation back down. A number of countries in the region also have large external debts and/or widening current account deficits. These countries will need to follow policies that will reduce rollover risk and prevent a reversal of capital inflows. The appropriate policy mix will depend on the particular circumstances of each country, but would typically call for fiscal and monetary tightening, possibly allowing greater exchange rate flexibility, where appropriate. Such a stance would be relevant in countries where there has been an extended and significant period of fiscal and/or monetary stimulus, such as Algeria, Azerbaijan, and Iran. In countries where overheating has been underpinned by capital inflows, the tightening of macroeconomic policies could contain the rise of current account deficits, reduce external vulnerability, and boost investors’ confidence. This is particularly important in Pakistan, where a strong fiscal effort and an end to central bank financing of the government are needed to contain the growing fiscal deficit and protect international reserves. In countries where the pickup in inflation has been triggered mainly by rising food and fuel prices, vigilance is needed to anchor inflation expectations and prevent the increase in headline inflation from spilling over into broader wage and price increases. This is especially relevant in Jordan, where reining in the current account deficit of over 17 percent of GDP in 2007 is also a key policy challenge.

In oil-exporting countries with currencies pegged to the U.S. dollar, it will be a challenge to control inflation as long as there is continuing monetary easing in the United States. Changing the exchange rate regimes of the GCC countries at this time could be disruptive to the run-up to the planned monetary union. While the monetary authorities and financial regulators could tighten reserve requirements and prudential norms, the burden of adjustment may fall on fiscal policy. However, the room for maneuver of fiscal policy is also limited by the need for higher investment to alleviate supply bottlenecks and the political pressure for higher wages and higher spending on social programs. Nevertheless, inflation could be slowed by containing the growth of public sector wages and of other current outlays while phasing the implementation of large investment projects (with priority being given to projects that would alleviate supply bottlenecks). Fiscal policy could revert to a stance that is consistent with medium-term objectives when inflation is back under control and/or in the context of a new monetary framework. This would be particularly the case in Libya (to some extent), Oman, Qatar, and the U.A.E. In Kuwait, given the somewhat greater exchange rate flexibility, adjustment policies could aim to strike the right balance between fiscal tightening—which would require resisting pressures for greater government spending—and currency appreciation.

Tolerating somewhat higher inflation for a while may be necessary for the GCC countries. Rising inflation at least partly reflects the adjustment to a higher real equilibrium exchange rate under the peg. Although in the short term tighter fiscal policy could help contain inflation, this may be politically difficult if citizens press for a broader distribution of their countries’ oil wealth. Clearly, the optimal response to an increase in oil wealth would include an appropriate increase in consumption, including by the government. If this consumption is not to lead to inflation, however, it will be critical for the government to help expand absorptive capacity, particularly by investing in the nontradable sector, such as in infrastructure and social services.

In countries where inflation is less of a concern, fiscal policy could play a useful role in supporting the economy should it be affected more significantly by a downturn in advanced economies. However, this should be consistent with their medium-term fiscal consolidation goals. If there is room to provide a fiscal stimulus, it should be directed toward investment spending in support of sustainable growth over the medium term. In Kazakhstan, given the large budget surplus, and in view of the pressing social and infrastructure needs, there is room for some limited fiscal expansion to cushion the negative shock from the turmoil in international financial markets. However, faced with a possible severe disruption of external financing flows, some countries may need to respond by tightening policies promptly to maintain confidence.

Beyond the immediate short-term macroeconomic challenges, policies need to remain focused on strengthening macroeconomic policy frameworks, promoting sound financial deepening, and supporting the growth potential of the private sector:

  • All countries in the region need to continue elaborating and adopting fiscal policy frameworks tailored to addressing specific issues in their fiscal outlook, most notably the efficient and sustainable use of oil revenues in oil-exporting countries—particularly in countries where reserves are dwindling (Syria and Yemen)—and high public debt in emerging market economies and some low-income countries (Djibouti, the Kyrgyz Republic, Mauritania, and Sudan). A medium-term framework can help link annual budgets to longer-term policies and fiscal sustainability objectives, and enhance risk analysis. These frameworks are especially important in countries where major fiscal reforms—such as introducing a value-added tax or phasing out large energy subsidies—are needed to underpin a medium-term fiscal adjustment strategy, or where large investment projects may entail significant recurrent budgetary outlays over the medium term.

  • The experience with previous oil booms highlights the importance of sound institutions and public financial management systems for oil-producing countries. These countries face the challenge of balancing the need to create jobs and improve living standards for the current generation of citizens while at the same time preserve an equitable share of the oil wealth for future generations. To this end, many countries have established oil funds, commonly referred to as Sovereign Wealth Funds (SWFs). While the nature of these funds differs across countries, their main objective is to facilitate the saving of the proceeds from renewable resources and help reduce boom-and-bust cycles resulting from changes in oil prices. The role of SWFs has gained attention recently, and led to a call for greater transparency in their management to help avert protectionist tendencies in recipient countries (Box 9). The IMF, in collaboration with the SWFs, has been charged with facilitating the design of a voluntary code of best practices.

Sovereign Wealth Funds in the Spotlight

With the rapid increase in the number and size of SWFs, questions are being raised about their transparency and impact on global financial stability.

What Are SWFs?

There is no single definition of an SWF, but they can be described as special-purpose government funds that hold and manage assets of the economy for long-term objectives. The funds in the MCD region typically invest abroad the accumulated savings from hydrocarbon revenue. According to the IMF’s October 2007 Global Financial Stability Report, SWFs can be broadly distinguished based on their main objective:

  • stabilization funds, designed to insulate the budget and the economy against volatile commodity (usually oil) price changes;

  • savings funds for future generations, which aim to convert nonrenewable nonfinancial assets into a more diversified portfolio of assets yielding higher returns;

  • reserve investment funds, which are established to increase the return on international reserves;

  • development funds, for funding socioeconomic projects or promoting industrial polices that might raise a country’s potential output growth; and

  • contingent pension reserve funds, for covering contingent unspecified pension liabilities on the government’s balance sheet.

SWFs help avert boom-bust cycles in their home countries and facilitate the saving and transfer across generations of proceeds from fiscal surpluses. Compared with central bank–managed reserve assets, SWFs allow for greater portfolio diversification and focus more on generating higher returns. Although SWFs have existed for a long time (e.g., the Kuwaiti Reserve Fund for Future Generations was started in 1953), they have grown in number and size owing to high oil prices, financial globalization, and continued imbalances in the global financial system that have facilitated rapid accumulation of foreign assets by some countries. The IMF estimates that SWFs will rise from US$2–US$3 trillion today to about US$6–US$10 trillion within five years, with the GCC countries holding about one-half of these assets (Table B9.1). While SWFs are sizable when compared with global financial assets, they are relatively small as a share of world financial and real assets—a more appropriate comparison given that SWFs invest in both financial and real assets.

SWFs are widely perceived to have played a stabilizing role in markets, possibly because their long investment horizons are likely reflected in longer investment holding periods. This sentiment has been reinforced by recent capital injections (over US$40 billion since November 2007) by SWFs into European and U.S. banks in the wake of the U.S. subprime crisis. Nevertheless, the recent substantial increase in SWF assets has raised concerns about their lack of transparency, the expanded role of governments in international markets and industries, and the potential of SWFs for carrying out transactions based on noncommercial motives. In contrast, countries with SWFs are concerned about protectionist restrictions on their investments, which could hamper the international flow of capital.

Table B9.1.

Estimates of Assets Under Management for MCD SWFs

(In billions of U.S. dollars; as of February 2008)

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Sources: Brad Setser’s Report; Deutsche Bank; Morgan Stanley; and Petersen IIE.

Toward a Voluntary Set of Best Practices

Recognizing the growing importance of SWFs and the role of the IMF in monitoring the health of its member countries’ economies and the global financial system, the International Monetary and Financial Committee—the IMF’s governance body—called on the IMF in October 2007 to collaborate with SWFs and other stakeholders in developing a voluntary set of best practices in the management of SWFs.

To that end, the IMF organized a roundtable of sovereign asset and reserve managers in November 2007 to enhance the understanding of SWFs. The IMF is also undertaking a survey to help identify SWFs’ institutional frameworks, investment objectives, and risk management practices, and plans to coordinate the work of an international working group to help develop best practices for current and planned SWFs. The objective will be to formulate best practices that are fair to both investing and recipient countries, cost-effective in terms of resources for monitoring compliance, and capable of facilitating open international capital flows and cross-border investments.

  • Many countries in the region continue to rely on price subsidies on food and energy products to increase their affordability to low-income households. Price subsidies are not, however, an efficient way to achieve this social objective because they distort resource allocation and benefit the rich more than the poor. Given that high food and fuel prices are likely to persist, phasing out price subsidies will be essential for maintaining fiscal sustainability, enhancing the efficiency of fiscal spending, and improving equity. The adverse social effects of this reform on the poor should be mitigated by establishing social safety nets that better target the poor, including through direct income or cash transfers. The pace of price adjustment should strike the right balance between minimizing the risk of destabilizing inflation expectations associated with a sharp increase in prices versus the adjustment fatigue resulting from a lengthy drawn-out series of price adjustments. An effective communication strategy—that stresses the inequitable nature of the subsidies, their fiscal costs, and the trade-offs in the use of public funds—is also important for the success of the reform.

  • For countries where greater exchange rate flexibility is desirable over the medium term, further work is needed to lay the foundation for an independent monetary policy. This would include assigning a mandate to the central bank to maintain low and stable inflation, and developing market-based instruments of monetary control. It would also require strengthening the research and forecasting capabilities of central banks to develop their understanding of the monetary transmission mechanism (Morocco and Tunisia).

  • Despite the difficult challenges ahead, GCC countries need to work closely and speedily on keeping the agenda of the proposed monetary union on track, including reaching consensus among all parties on the appropriate common exchange rate regime to be adopted in this context.

  • Strengthening the banking system remains a top priority. A healthy and dynamic financial system is key to sustained higher growth and lower unemployment in the region. It is also a prerequisite for a country to successfully integrate into the world economy. Notwithstanding the significant progress achieved over the past decade, important challenges remain. The banking sectors of some countries are still saddled with relatively high nonperforming loans. Dealing with these large stocks of nonperforming loans will be essential to lower the cost of borrowing and increase the availability of new credit. In this context, strengthening banking regulation and supervision will be important, particularly in countries experiencing fast credit growth. Rapid credit expansion can undermine the quality of banks’ portfolios if the capacity of these banks to assess the creditworthiness of borrowers fails to keep pace with the growth of their lending. Moreover, banks’ exposure to exchange rate risk needs to be monitored carefully in cases (like Kazakhstan) where banks rely heavily on foreign borrowing to fund their domestic lending. Fortunately, while nonperforming loans have started to rise in Kazakhstan, other indicators of financial soundness remain broadly satisfactory. For most countries, competition and efficiency would be enhanced by restructuring and privatizing inefficient state banks, and by developing local debt markets.

  • Given the recent rapid rise in house prices in many countries in the region, policymakers should closely monitor developments in this area and assess vulnerability to a property price correction (Box 10). The current turmoil in international financial markets triggered by massive defaults on subprime mortgages in the United States has revived the debate over how monetary policy should respond to housing price developments. Housing price corrections could slow economic activity considerably by dampening both residential investment and private consumption, particularly if homes are increasingly used as collateral for household borrowing. The recent experience in developed countries seems to support the case for giving greater weight to asset price movements when gauging a country’s monetary policy stance.

  • The private sector is essential for the expansion and diversification of the production and export base of MCD economies, and for the creation of jobs for the rapidly growing labor force. Among the key policies to promote growth of the private sector are initiatives to improve the investment climate and lower the cost of doing business, including by reducing barriers to trade and pervasive government controls and regulations, enhancing the transparency of the legal and administrative systems, improving labor market flexibility, and reforming the educational system and promoting training to reduce the mismatch between the skill sets of workers seeking a job and those required by potential employers. The recent initiative to pursue this reform agenda in the context of the regional integration in the Maghreb countries is a good example for other MCD countries to follow.

Real Estate Prices in the MCD Region

Although lack of data hampers analysis, there is some evidence of significant price inflation in the region’s real estate markets. However, differences remain over whether a property price bubble exists in selected economies or prices have simply responded to economic fundamentals.

A number of factors may have contributed to price inflation in the real estate market. In some hydrocarbon-rich countries, particularly in the GCC countries, the housing market boom has been spurred by rapid population growth driven by a large inflow of expatriates, the opening up of real estate markets to foreign investors, a sharp increase in the price of imported raw materials, and expansionary fiscal and monetary policies. Rising oil prices have also benefited non-oil countries through direct investment by oil exporters, particularly in real estate (Egypt, Morocco, Pakistan, and Tunisia) or rising remittances flows, which are typically used to acquire real estate in the home country. In Kazakhstan, the significant increase in property prices has been driven mainly by rapid credit growth. Migration in Egypt and Jordan as a result of civil unrest in neighboring countries, and a lack of alternative investment vehicles in Iran may have also contributed to the rapid rise in real estate prices.

While data availability is scarce in general, there is some information available for specific markets1 (Table B10.1). In Saudi Arabia, property prices are still recovering from the downturn in 2006, while other GCC countries have seen very large valuation increases, leading to a GCC-wide rise of about 25 percent a year. In Bahrain, for example, a relaxation of acquisition constraints on foreigners led to an influx of Saudi nationals who prefer to commute.

Moreover, the concentrated ownership of land by the state in GCC countries limits the private sector’s ability to increase supply to meet housing shortages.

In Central Asia, house prices have increased rapidly in several major cities over the past two years, including in Almaty, Bishkek, and, more recently, Dushanbe (Figure B10.1). In Kazakhstan, the boom came to an abrupt halt as banks lost easy access to foreign borrowing when global liquidity conditions tightened. The housing boom was fueled mainly by foreign-financed commercial bank lending, putting the Kazakhstani banking system under strain.

Table B10.1.

Housing Price Developments in the GCC countries

(Average, 2005 = 100)

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Source: www.mazayaindex.com.
Figure B10.1.
Figure B10.1.

Property Price Indices in Central Asia

Sources: Data provided by country authorities; and www.proinvest.kg.

The sparse data available show that affordability of housing varies widely across the region (Table B10.2). In the Maghreb, high property prices (relative to income) conceivably restrict access to housing, especially for lower income groups. Consequently, some countries in the region, such as Morocco and Tunisia, have public housing programs and subsidized mortgages, targeted to specific income or age groups, to increase home ownership. However, the affordability index should be interpreted with caution given that it is based on aggregate data. A more revealing analysis would require the affordability index for different levels of income distribution.

The scarcity of data does not allow conclusive inference as to whether property prices are out of line with economic fundamentals or whether recent reforms in the real estate market have allowed real estate prices to catch up with economic developments. Given the importance of the real estate market for growth and financial stability, greater attention needs to be paid to the collection and analysis of adequate statistical information on real estate markets.

Table B10.2.

Affordability of Apartments in Selected Economies1

(Price per square meter in percent of annual per capita income)

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Sources: Price per square meter from www.globalpropertyguide.com; and per capita income from IMF, World Economic Outlook.1 The affordability index shows the price per square meter of residential apartments (in U.S. dollars) for sale in prime locations in the administrative or financial capital relative to per capita income (converted at purchasing-power-parity-adjusted exchange rates). The property prices were collected in 2007, except for Korea, Mexico, and Tunisia (all 2005).

1 Data availability is somewhat better for rents because these are generally included in the CPI. However, CPI data are often not available at a disaggregated level. Moreover, rental price indices can be heavily influenced by administered prices—e.g., public housing subsidies and rent controls—and therefore may not reflect market prices.


Based on the IMF’s April 2008 World Economic Outlook.


IMF staff estimates suggest that global demand responds to price changes with a lag of up to four years, owing to limited pass-through of increases in oil prices to consumers in developing countries and to rigidities in households’ energy demand in some industrial countries.

Statistical Appendix

Data and Conventions

The IMF’s Middle East and Central Asia Department (MCD) countries comprise Afghanistan, Algeria, Armenia, Azerbaijan, Bahrain, Djibouti, Egypt, Georgia, Iran, Iraq, Jordan, Kazakhstan, Kuwait, the Kyrgyz Republic, Lebanon, Libya, Mauritania, Morocco, Oman, Pakistan, Qatar, Saudi Arabia, Somalia, Sudan, Syria, Tajikistan, Tunisia, Turkmenistan, the United Arab Emirates (U.A.E.), Uzbekistan, Yemen, and the West Bank and Gaza.

The following statistical appendix tables contain data for 30 of the MCD countries. Somalia and the West Bank and Gaza are not included because of limited data availability. Afghanistan, Iraq, and Turkmenistan are included in the tables, but excluded from the country grouping averages in all the tables except Tables 2, 3, 5, 14, 15, 16, and 19. Data revisions reflect changes in methodology and/or revisions provided by country authorities.

The data relate to the calendar year, with the following exceptions: (1) for Qatar, fiscal data are on a fiscal year (April/March) basis; and (2) for Afghanistan, Egypt, Iran, and Pakistan, all macroeconomic accounts data are on a fiscal year basis. For Egypt and Pakistan, the data for each year (e.g., 2004) refer to the fiscal year (July/June) ending in June of that year (e.g., June 2004). For Afghanistan and Iran, data for each year refer to the fiscal year (March 21/March 20) starting in March of that year, except Table 5, which contains data on a calendar year basis.

In Tables 4, 10, and 11, “oil” includes gas, which is also an important resource in several countries.

REO aggregates are constructed using a variety of weights as appropriate to the series:

  • Country group composites for exchange rates and the growth rates of monetary aggregates (Tables 7 and 18) are weighted by GDP converted to U.S. dollars at market exchange rates (both GDP and exchange rates are averaged over the preceding three years) as a share of MCD or group GDP.

  • Composites for other data relating to the domestic economy (Tables 1,4,6, and 813), whether growth rates or ratios, are weighted by GDP valued at purchasing power parities (PPPs) as a share of total MCD or group GDP.

  • Composites relating to the external economy (Tables 17 and 20) are sums of individual country data after conversion to U.S. dollars at the average market exchange rates in the years indicated for balance of payments data and at end-of-year market exchange rates for debt denominated in U.S. dollars.

  • Tables 2, 3, 5, 1416, and 19 are sums of the individual country data.

CCA (the Caucasus and Central Asia) comprises Armenia, Azerbaijan, Georgia, Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan.

MENA (Middle East and North Africa) refers to the following countries covered by the MCD: Algeria, Bahrain, Djibouti, Egypt, Iran, Jordan, Kuwait, Lebanon, Libya, Mauritania, Morocco, Oman, Qatar, Saudi Arabia, Sudan, Syria, Tunisia, the U.A.E., and Yemen.

GCC (Gulf Cooperation Council) is composed of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the U.A.E.

Maghreb comprises Algeria, Libya, Mauritania, Morocco, and Tunisia.

Table 1.

Real GDP Growth

(Annual change; in percent)

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Sources: Data provided by country authorities; and IMF staff estimates and projections.
Table 2.

Nominal GDP

(In billions of U.S. dollars)

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Sources: Data provided by country authorities; and IMF staff estimates and projections.
Table 3.

GDP at Purchasing-Power-Parity Prices

(In billions of U.S. dollars)

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Source: IMF, World Economic Outlook.
Table 4.

Oil and Non-Oil Real GDP Growth for Oil Exporters

(Annual change; in percent)

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Sources: Data provided by country authorities; and IMF staff estimates and projections.
Table 5.

Crude Oil Production and Exports

(Millions of barrels a day)

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

Excludes exports of refined oil products.

Table 6.

Consumer Price Inflation

(Year average; in percent)

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Sources: Data provided by country authorities; and IMF staff estimates and projections.
Table 7.

Broad Money Growth

(Annual change; in percent)

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

Broad money is defined to include nonresident deposits (M5).