Jihad Azour
Director of the Middle East and Central Asia Department at the International Monetary Fund

Never Let a Crisis Go to Waste

Now is the time to address vulnerabilities in the Middle East and Central Asia’s emerging economies

Emerging market economies in the Middle East and Central Asia are confronting one of the most severe and widespread crises ever, with a confluence of fast-moving shocks ranging from the COVID-19 pandemic to financial market volatility, a plunge in oil prices, and domestic lockdown. The IMF currently expects this diverse group of economies—Armenia, Bahrain, Egypt, Georgia, Jordan, Kazakhstan, Lebanon, Morocco, Oman, Pakistan, Saudi Arabia, Tunisia, and the United Arab Emirates—to contract by 1.7 percent in 2020.

The pandemic is taking a toll on lives and livelihoods, and its full human and economic impact is still unknown. This crisis is also bringing to light external and fiscal vulnerabilities, which are limiting policy options for dealing with the economic fallout. If left unaddressed, these vulnerabilities could lead to a protracted economic recession with heightened regional uncertainty and other possible repercussions including social unrest.
Wide-ranging challenges

The region’s oil exporters are being hit by a dual blow to their fiscal and external positions from the plunge in oil prices by more than 50 percent since January, reaching its lowest level in nearly twenty years. At the same time, stay-at-home rules and other COVID-19 containment measures are disrupting tourism, transportation, and construction. As a result, fiscal balances will likely turn negative, exceeding 10 percent of GDP in several countries.

Many of the region’s oil importers—such as Egypt, Jordan, Morocco, Pakistan, and Tunisia—entered the crisis with varying degrees of macroeconomic challenges. In addition, gains from lower oil prices are being offset by falling remittances and the pandemic’s impact on tourism and related sectors. For example, remittances amount to about 8 percent of GDP in Egypt and Pakistan and 13 percent of GDP in Lebanon, while retail and hospitality account for over 15 percent of GDP in Kazakhstan and Lebanon.

Public debt in the region’s emerging economies is expected to increase by $127 billion by end-2020, considerably limiting the scope for a strong fiscal response. As revenue falls short, countries like Oman and Tunisia have had no choice but to cut spending, while others such as UAE and Kazakhstan may see their non-oil fiscal position deteriorate markedly.

Moreover, financial conditions remain highly volatile. March and April saw sudden reversals of capital flows from emerging markets generally, with the region experiencing about $6 billion in outflows. While some of the regional emerging markets (e.g., Saudi Arabia, UAE, and Bahrain) regained access to international capital markets, others experienced capital outflows and a spike in sovereign spreads. Countries in the region could also face the challenge of refinancing up to $24 billion in maturing external sovereign debt in 2020, especially in countries where domestic financial markets are underdeveloped.

Nonetheless, countries are responding swiftly and decisively to the crisis. Several oil exporters have announced a raft of fiscal measures to support demand, while others (including Oman, Bahrain, and Saudi Arabia) have had to cut spending, including in investment, due to fiscal constraints. Many have also introduced measures to support the cash flows of affected sectors and ease credit markets, and seven central banks, including those of Bahrain, Morocco, and the United Arab Emirates, have injected about $50 billion into their financial systems to support liquidity.

Getting all the policies right and on time will be a tall order for many of those countries. But policymakers need to prepare now for a strong recovery. In addition to prioritizing spending on health care, governments in the region could take the following steps:

Stand ready to provide further liquidity to banks, particularly those lending to small and medium-sized enterprises, while closely monitoring financial sector stability.
Carefully manage financing and further develop and deepen local financial markets to enhance debt management and meet financing needs.
Postpone nonessential spending, especially when public debt is already high, and rationalize capital expenditure as part of a plan to rebuild buffers. In addition, it would be prudent to redirect spending to critical areas to put the economy on a sustainable medium-term fiscal path.

What does the future hold?

As the peak of the crisis recedes, countries are facing sizable uncertainty as to how the phased reopening might impact the recovery, the evolution of oil prices, and the persistence of capital flow pressures. Elevated debt levels and associated financing vulnerabilities could further hinder capital inflows and constrain fiscal policy. Countries with high debt and weak fundamentals, facing tight financial conditions, may need to rely on official financing.

The IMF is actively supporting the region and has already provided $10 billion to emerging market countries of the Middle East and Central Asia. Egypt, Pakistan, Tunisia, and Jordan have received emergency assistance under IMF’s Rapid Financing Instrument; Morocco has opted to draw on its Precautionary Liquidity Line to boost reserve buffers and help manage needs arising from the shock; and the ongoing IMF programs for Armenia, Georgia, Jordan, and Pakistan have been adapted and, in Armenia and Georgia’s cases, augmented to accommodate COVID-19 spending.

Even as the region’s emerging markets grapple with the immediate impact of the crisis, the pace of their recovery and medium-term prospects will depend on the strength of domestic policy responses and reforms, as well as their macroeconomic vulnerabilities. There will inevitably be challenges ahead and the process of stabilization may take time. As investors become more discerning about countries’ vulnerabilities and risks, the region’s emerging markets are likely to experience differentiated treatment depending on their credit quality. This makes it all the more important to ensure strong domestic policy responses that would provide a strong foundation for recovery.