Toward New Horizons: Arab Economic Transformation Amid Political Transitions; Middle East and Central Asia Department Paper 14/01; April 11, 2014

InternatIonal Monetary Fund

Middle East and Central Asia Department

Toward New Horizons

Arab Economic Transformation Amid Political Transitions

Prepared by a staff team led by Harald Finger and Daniela Gressani,

comprising Khaled Abdelkader, Khalid AlSaeed, Alberto Behar, Sami Ben Naceur,

Christine Ebrahimzadeh, Asmaa El-Ganainy, Samar Maziad, Aiko Mineshima,

Pritha Mitra, Preya Sharma, Charalambos Tsangarides, and Zeine Zeidane

Toward New Horizons

Arab Economic Transformation Amid Political Transitions

Middle East and Central Asia Department

Prepared by a staff team led by Harald Finger and Daniela Gressani,

comprising Khaled Abdelkader, Khalid AlSaeed, Alberto Behar, Sami Ben Naceur,

Christine Ebrahimzadeh, Asmaa El-Ganainy, Samar Maziad, Aiko Mineshima,

Pritha Mitra, Preya Sharma, Charalambos Tsangarides, and Zeine Zeidane

INTERNATIONAL MONETARY FUND

Cataloging-in-Publication Data

Joint Bank-Fund Library

Toward new horizons: Arab economic transformation amid political

transitions / prepared by a staff team led by Harald Finger and

Daniela Gressani comprising Khaled Abdelkader [and eleven

others]. – Washington, D.C. : International Monetary Fund, c2014.

“Middle East and Central Asia Department.”

Includes bibliographical references.

ISBN 978-48431-146-2

1. Economic development—Arab countries. 2. Arab countries—

Economic policy. 3. Fiscal policy—Arab countries. 4. Monetary

policy—Arab countries. 5. Foreign exchange rates—Arab countries.

I. Finger, Harald. II. Gressani, Daniela, 1956– III. Abdelkader,

Khaled. IV. International Monetary Fund. V. International Monetary

Fund. Middle East and Central Asia Department.

HC498.A73 2014

Disclaimer: The views expressed herein are those of the authors and

should not be reported as or attributed to the International Monetary

Fund, its Executive Board, or the governments of any of its member

countries.

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Internet: www.imfbookstore.org

iii

Contents

Acknowledgments vii

Preface ix

1. Introduction and Summary 1

2. Tackling Fiscal Challenges 8

3. Monetary and Exchange Rate Policy for Stability, Growth,

and Jobs 29

4. Bolstering Financial Stability and Development 40

5. Reform for Sustainable, Job-Creating, Private Sector–Led Growth 61

6. Managing Economic Change During the Transitions 83

References 97

Boxes

Box 2.1. Mixed Public Views on Cutting Energy Subsidies 16

Box 2.2. Progress on Decentralization 21

Box 2.3. Tax Potential and Revenue Gaps in Non-Oil ACTs 24

Box 6.1. A Stylized Approach to Building Coalitions 89

Box 6.2. Continuing Need for Stepped-Up Donor Support 93

Box 6.3. Lessons from the Arab Transitions for the IMF 94

Figures

Figure 2.1. Fiscal Positions Have Deteriorated 9

Figure 2.2. Subsidies, Transfers, and Wages Were Raised 9

Figure 2.3. Crowding Out of Private Sector Credit, 2010–13 10

Figure 2.4. Government Finances 11

Figure 2.5. A 5 Percent of GDP Increase in Public Investment

Would Signiﬁ cantly Impact Growth and Employment 13

Figure 2.6. High Public Wage Bills 14

Figure 2.7. High Public Wages Tend to Raise Inequality 15

Figure 2.8. Large Variation in the Quality of Public Investment Management

CONTENTS

Figure 2.9. Scope for Additional Revenue Collection

Figure 2.10. Scope for Raising Property and Excise Tax Rates

Figure 3.1. Signiﬁ cant Macroeconomic Impacts from the

Political Transitions

Figure 3.2. External Developments

Figure 3.3. International Reserves Have Dropped Since the Onset

of the Transition

Figure 3.4. Inﬂ ation in Most ACTs Has Remained below the Emerging

Market Average

Figure 3.5. Real Effective Exchange Rates Have Appreciated in Some ACTs

Figure 3.6. Real and Nominal Volatility, 2000–12

Figure 4.1. Bank Credit is Large in Most ACTs

Figure 4.2. Few Firms Use Bank Credit to Finance Investments

Figure 4.3. Relatively Few People in the ACTs Maintain Bank Accounts

Figure 4.4. Access to Finance is a Major Constraint

Figure 4.5. Nonperforming Loans are High

Figure 4.6. ACTs Rank Last in Legal Rights

Figure 4.7. Bank Concentration is High

Figure 4.8. Government Debt Markets Remain Underdeveloped

Figure 4.9. Stock Markets are Large in Some ACTs

Figure 4.10. Private Institutional Investors are Lacking in Some Countries

Figure 4.11. Potential for Developing the Investor Base

Figure 4.12. Global Assets of Islamic Finance Have Grown

Figure 5.1. Lagging Growth and High Unemployment

Figure 5.2. More Investment is Needed to Support Growth

Figure 5.3. Large Potential for Higher Exports

Figure 5.4. Strong Trade Links with Europe

Figure 5.5. Signiﬁ cant Trade Barriers

Figure 5.6. Intraregional Share of Exports and Stock of Foreign Direct

Investment

Figure 5.7. Improvements from Trade Facilitation in Morocco

Figure 5.8. Business Licensing and Permits are Major Constraints

Figure 5.9. Governance and Corruption are Increasingly Serious

Concerns

Figure 5.10. Doing Business Rankings Improve with Income

Figure 5.11. Doing Business Reform Efforts Have Been Set Back

Figure 5.12. Excess Labor Regulations and Education Mismatches

Contents

Figure 5.13. Large Total and Youth Unemployment

Figure 5.14. The Public Sector is a Large Employer in MENA

Figure 5.15. Government is the Preferred Employer for Arab Youth

Figure 5.16. Rural Poverty is Signiﬁ cant

Figure 5.17. Many People are Vulnerable to Falling into Poverty

Figure 5.18. Social Safety Nets are Small

Figure 5.19. Social Safety Net Coverage is Limited

Figure 5.20. Limited Awareness of Social Safety Nets in the Lowest

Income Quintile

Figure 6.1. Political Risk Has Increased

Figure 6.2. Perception of Arab Youth about Direction of the Economy

Figure 6.3. Rule of Law Ranking Shows Room for Improvement

Figure 6.4. Government Effectiveness Has Suffered in Most ACTs

Tables

Table 2.1. Room for Improvement in Tax Effort and

VAT Collection Efﬁ ciency

Table 2.2. Non-Oil ACTs: Base Broadening Recommendations

Table 2.3. Scope for More Income Tax Progressivity

Table 3.1. Structural and Exchange Rate Characteristics

Table 5.1. Poverty Remains an Important Concern

Table 6.1. Strong Use of Social Networks for Political and Community Views

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vii

Acknowledgments

The paper is the outcome of an interdepartmental project of the IMF’s

Middle East and Central Asia Department with the Communications, Fiscal

Affairs, Monetary and Capital Markets, Research, and Strategy, Policy, and

Review Departments.

The authors would like to thank Masood Ahmed, Director of the Middle

East and Central Asia Department, for his guidance and comments. They are

also thankful for advice and support in coordination from Prakash Loungani,

David Marston, Marco Pinon, Christoph Rosenberg, and Abdel Senhadji; and

for guidance on political economy issues from Raj Desai.

Thanks are also due to Yasser Abdih, Abdul Malik Al-Jaber, Nabil Ben Ltaifa,

Ralph Chami, Jean-François Dauphin, Shantayanan Devarajan, Ishac Diwan,

Gilda Fernandez, Edward Gemayel, Christopher Jarvis, Juha Kähkönen,

Alfred Kammer, Kristina Kostial, Inutu Lukonga, Amine Mati, Tokhir

Mirzoev, Eric Mottu, Gaelle Pierre, Bjoern Rother, Randa Sab, Nasser Saidi,

Hossein Samiei, Carlo Sdralevich, Gazi Shbaikat, Natalia Tamirisa, Shahid

Yusuf, and Younes Zouhar for providing comments at various stages of

drafting the paper.

Special thanks are due to Gohar Abajyan and Jaime Espinosa-Bowen for their

research assistance, Kia Penso for her editorial contributions, Cecilia Prado

de Guzman for assistance with formatting and document preparation, and

Joanne Johnson and Katy Whipple for editorial guidance and production

support.

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Preface

The transformations in the Arab world that began three years ago had their roots not

only in demands for more voice and participation but also in a growing frustration with

the economic environment where job opportunities were few and connections seemed

to be more important than merit in accessing the gains from economic growth. Since

then, governments in these countries have been pursuing country-speciﬁ c agendas of

political and constitutional reform, but they have also had to grapple with heightened

macroeconomic vulnerabilities, the effect, in part, of a worsening international, regional,

and domestic environment on private sector conﬁ dence and growth. The near-term

economic outlook continues to be challenging and subject to downside risk, and so the

focus on maintaining macroeconomic stability will remain a key priority for the coming year.

However, it is also important for these governments to embark on the bold reform

agendas that will make for more dynamic and inclusive economies, generate more

jobs, and provide equal access to economic opportunity for all segments of society.

Unless strong economic and ﬁ nancial reforms are implemented, a gradual economic

recovery will not be enough to bring a meaningful reduction in the region’s high rates of

unemployment in coming years, particularly among women and youth.

Realizing the economic potential of the Arab Countries in Transition lies ﬁ rst and

foremost in the hands of countries’ governments. But the international community,

including the IMF, can help. With the beneﬁ t of hindsight, it has become clear that

in past years we paid insufﬁ cient attention to growing socioeconomic imbalances and

unequal access to economic opportunity. The Arab transitions have thus prompted us

to step back and rethink our approach to economic policy recommendations for the

countries undergoing transition. While we have been actively engaged in all transitioning

countries, with a focus on macroeconomic stabilization and policies in support of

economic development, we have to date not laid out our comprehensive view on

the macroeconomic and structural policies that we see as essential for safeguarding

macroeconomic stability and putting in place the right conditions for high, sustainable,

and inclusive growth. This publication attempts to ﬁ ll that gap and to provide our

intellectual contribution to the ongoing discussion on setting the right policies in the

Arab Countries in Transition.

In this spirit, I hope that this publication will be of use for policymakers and other

stakeholders in the countries undergoing transition, and for the international community

that supports them, in order to enable an economic transformation that will respond to

the hopes and aspirations of their young and dynamic population.

Masood Ahmed

Director, Middle East and Central Asia Department

International Monetary Fund

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CHAPTER

Introduction and Summary

The political transitions in the Arab world have created an opportunity

for economic transformation. The political landscape is changing and new

stakeholders have become active, while old vested interests standing in the

way of reform may have been weakened. This setting provides a historic

opportunity to rethink the economic reform agenda and tackle longstanding

economic issues that were previously difﬁ cult to approach.

Nevertheless, three years after the onset of political transition in the Arab

world, managing the transitions and implementing necessary economic

policies has proven to be challenging. The Arab Countries in Transition

(ACTs), including countries that have undergone regime change (Egypt,

Libya, Tunisia, Yemen) and those that have engaged in transformation under

existing regimes ( Jordan, Morocco), have progressed along their transition

paths. Governments with limited horizons and mandates, institutional

uncertainty, and socioeconomic tensions have been hindering, to varying degrees

across countries, the focus on the economic transformation agenda. At the

same time, challenges in economic management have intensiﬁ ed, as external

and domestic economic conditions have been complex, policy buffers are

running low, and economic growth is insufﬁ cient to bring down the ACTs’

high unemployment. In this setting, countries are at a critical juncture: prudent

economic management, paired with bold reform efforts to create an enabling

environment for private sector–led growth, will be needed to safeguard the

promise of the Arab transitions for better living conditions, higher and more

inclusive growth, and job creation on a meaningful scale.

The ACTs have been facing a number of longstanding economic challenges.

Well before the beginning of the transitions in 2011 in economic growth

per capita and integration into the world economy they were lagging behind

other emerging market and developing countries (EMDCs), and there was

a perceived lack of competition in domestic markets. Unemployment in the

ACTs was high, running at more than double the average rate of EMDCs,

and youth unemployment was among the highest in the world. There was a

TOWARD NEW HORIZONS

widespread perception that the beneﬁ ts of growth were chieﬂ y captured by

the well-connected, while others felt marginalized. Many countries carried

substantial public debt, and some were running high ﬁ scal deﬁ cits. The ACTs’

tendency to limit movements in their exchange rates helped provide an anchor

for inﬂ ation but also constituted an important source of vulnerability.

The private sector has lacked the dynamism needed for sustained job-

creating growth. It has been stiﬂ ed by government intervention: complex

and burdensome business regulation has constrained economic activity

and enabled corruption; state-owned enterprises and public banks have

often been dominant players in their sectors but have tended to operate

inefﬁ ciently, leading to ﬁ scal slippages and capital misallocation; and lack of

a level playing ﬁ eld between public and private enterprises, as well as among

private enterprises, has limited competition and innovation. Perceptions of

government effectiveness and control of corruption have been deteriorating

over time, and governments have been unable to create the infrastructure

needed to support a dynamic economy. As a consequence, competitiveness

has suffered. Where reforms were initiated, their top-down approach

has often meant that the resulting economic beneﬁ ts went largely to the

well-connected without generating tangible beneﬁ ts for most people—in

particular, without creating formal sector jobs or improving living standards.

Shortcomings in access to ﬁ nance, trade integration, infrastructure

investment, and the labor market and education system have also hampered

private sector–led growth. Access to ﬁ nance by businesses has been among

the lowest in the world, constraining private investment. A lack of trade

integration (and supporting policies) has meant that the region’s exports

have been far below their potential. Inadequate labor regulations have been

disincentives to private sector hiring, while the public sector has often taken

the role of employer of ﬁ rst and last resort—a role that has distorted the

labor market and education system, and one that governments can no longer

afford to play. In addition, ACTs, like other countries in the MENA region

more generally, have maintained large generalized subsidies as their main

vehicle for social protection. These subsidies are inefﬁ cient—their beneﬁ ts

accrue disproportionately to the wealthy—and they tie up scarce resources

that could be used for much-needed priority expenditure in areas like

infrastructure investment, health, and education.

These problems have become more acute since the onset of transitions in

2011, as popular expectations for better living standards have risen. The

ACTs have been faced with an economic downturn resulting from transition-

related disruptions, regional conﬂ ict, an unclear political outlook, eroding

competitiveness, a challenging external economic environment in the context

of the European crisis, and declining conﬁ dence. This downturn has worsened

the unemployment problem and led to stagnating living standards, and may

have reduced the medium-term growth potential in some countries, putting

Introduction and Summary

economic realities squarely at odds with the aspirations of the population

for an economic transformation that would provide quick returns in the form

of job creation and income generation. Demographic pressures suggest that,

under current baseline projections for GDP growth through 2018 of around

4¼ percent in the oil-importing ACTs, unemployment is expected to continue

rising. At the same time, ﬁ scal deﬁ cits and public debt have further increased,

and international reserve buffers have been run down, severely limiting the

policy space for expansionary economic policies in the period ahead.

In this setting, the ACTs risk getting trapped in a vicious circle of economic

stagnation and persistent sociopolitical strife. As economic realities fall behind

populations’ expectations, there is a risk of increased discontent, which could

further complicate the political transitions, impairing governments’ mandates

and planning horizons and, consequently, their ability to implement the

policies necessary to catalyze the much-needed economic improvement.

The political transitions have thus created not only new opportunities for

economic transformation but also the necessity to accelerate economic

reform. Strong economic management, and policies to bolster the business

environment, are needed to avoid a vicious circle and create in its place

a virtuous one where the right policies revive economic conﬁ dence and

generate inclusive economic growth. Better economic conditions can then

help reduce discontent and thereby smooth the political transitions.

The ACTs need a medium-term vision to set policies for their economic

future. Goals will differ among countries, reﬂ ecting their citizens’ aspirations;

but in all countries they need to be framed in an economic model that

provides a more level playing ﬁ eld, allows for greater integration into the

global economy, and creates an environment in which a dynamic private

sector can drive growth and create sufﬁ cient jobs for a growing labor force,

while governments provide adequate infrastructure and regulation, along with

basic services and targeted social protection.

At this critical juncture, three economic policy priorities are essential: enabling

additional job creation in the near term to lessen the risk of a vicious circle;

addressing macroeconomic vulnerabilities to safeguard economic stability; and

setting in motion necessary reforms to generate higher potential growth and

job creation in the coming years.

Near-term policies need to focus on quickly enabling job creation in order

to lessen the adverse impact of the post-Arab-Spring economic downturns.

Delays in the revival of private investment, in the context of impaired

economic conﬁ dence, indicate a need for governments to shore up economic

activity in the near term. Experience from other countries suggests that well-

designed infrastructure projects can create jobs and lay a better foundation for

private sector activity. With little room for further widening of ﬁ scal deﬁ cits

TOWARD NEW HORIZONS

in many countries, spending needs to be reoriented toward growth-enhancing

and job-creating public investment that stimulates private sector activity,

while protecting vulnerable groups through well-targeted social assistance.

Expenditure-side reforms should include redirecting social protection from

expensive and inefﬁ cient generalized subsidies to transfers that better target

the poor and vulnerable. In addition, containing public wage bills would

reduce expenditure rigidities and support ﬁ scal strategies for sustainability and

private sector job creation. Revenue measures should focus on broadening the

tax base and improving the efﬁ ciency of tax collection. Some ACTs also have

room for raising income tax progressivity and increasing excise and property

tax rates. Together, these policies would enhance equity while freeing scarce

resources for priority expenditure in infrastructure investment, health, and

education.

At the same time, near-term policies need to be anchored in medium-term

policy frameworks that maintain and strengthen economic stability. With

concerns about debt sustainability rising and ﬁ scal and external buffers

eroding, countries need to anchor their ﬁ scal policies in medium-term

frameworks that safeguard macroeconomic stability and debt sustainability.

In some cases, there may be room for scaling up deﬁ cits in the near term

when adequate ﬁ nancing is available and in the context of medium-term

adjustment programs. The slower the pace of ﬁ scal adjustment, the larger the

ﬁ nancing needs will be, underscoring the need to anchor policies in credible

medium-term consolidation plans; these will help secure the continued

willingness of creditors to provide the necessary ﬁ nancing.

Countries face trade-offs in monetary and exchange rate policy. Each country

will need to weigh the pros and cons of pegging versus exchange rate

ﬂ exibility on an individual basis. Inﬂ ation will need to be kept contained,

and inﬂ ation expectations well anchored. At the same time, a key near-term

challenge is to safeguard aggregate demand in the face of weak growth and

necessary ﬁ scal consolidation. In addition, capital ﬂ ows must be restored

so as to reverse the decline in reserves. This outcome would come from a

credible monetary and exchange rate policy that reduces the impact of real

shocks, supports measures to increase competitiveness, controls inﬂ ation, and

thus lays out a path for stable and job-creating growth. For countries that opt

for greater exchange rate ﬂ exibility, this would require the establishment of

a new anchor for monetary policy and stepped up technical capacity at the

central bank, while pegging implies the need to align ﬁ scal policy closely with

macroeconomic objectives.

Bolstering ﬁ nancial sector development will be essential to underpin

the recovery and broaden access to ﬁ nance for investment and growth.

Limited bank competition, a concentration of lending to large, established

companies, a generally poor ﬁ nancial infrastructure, and underdeveloped

capital markets suggest that large beneﬁ ts could be gained from strengthening

Introduction and Summary

ﬁ nancial development and access to ﬁ nance, and thereby bolstering

investment, growth, and job creation. Reforms should focus on increasing

competition among banks and strengthening their ﬁ nancial infrastructure,

deepening capital markets and developing their investor base, and making

available alternative ﬁ nancing instruments, Islamic ﬁ nance, and microﬁ nance.

A bold economic reform agenda will be essential for propelling private sector

activity and fostering a more dynamic, competitive, innovation-driven, and

inclusive economy. To achieve broad-based and sustainable growth, countries

need to move gradually away from state-dominated to private investment, and

from protected and rent-seeking enterprises to export-led growth and value

creation. Policies should aim at strengthening the revival of private sector

conﬁ dence and laying the foundations for higher potential growth. A key

goal will be to engineer a transformation for the public sector, a shift from

providing privileges such as public employment, subsidies, economic rents,

and tax exemptions, to providing basic economic services, adequate social

protection, better governance, a level playing ﬁ eld for all economic actors, and

a competitive environment for the private sector. Countries will begin their

efforts from different starting points and will have different reform objectives,

but there are some common areas that should be covered: these include trade

integration, business regulation and governance, labor market and education

reform, improved access to ﬁ nance, and better social safety nets (SSNs).

Deepening trade integration can offer signiﬁ cant beneﬁ ts. In addition to the

large potential direct gains of boosting exports and attracting productivity-

enhancing FDI, trade integration can serve as catalyst for reforms in other

areas that will help countries compete. Deeper trade integration will require

better access to advanced economy markets. It will also involve carefully

reducing further the ACTs’ tariffs and non-tariff trade barriers, and focusing

on the increasingly important areas of trade facilitation and export promotion .

Complex and burdensome business regulation needs to be tackled to unleash

entrepreneurial activity and private investment. It is essential to improve

the systems of checks and balances in domestic institutions to prevent the

exercise of arbitrary discretion and nontransparent intervention, and to

streamline business regulation with a view to cutting red tape and reducing

informality and corruption. Institutional and regulatory reform should aim at

reducing the scope for discretion, improving transparency, and strengthening

institutional autonomy and accountability.

Labor market and education reforms can provide incentives for hiring and

participation in the formal private sector labor market. Countries should

review labor market regulations with a view to reducing distortions that

discourage hiring and skills-building, while ensuring an adequate level

of social protection. Governments need to revisit their recruitment and

compensation policies to ensure that hiring does not exceed needs and salaries

TOWARD NEW HORIZONS

do not bias job-seekers toward the public sector. Education systems should

be improved and reoriented towards skills needed in the private sector. As

these policies take time to yield tangible results, countries should consider

employing active labor market policies to achieve quick improvements in labor

market outcomes.

Countries need to create efﬁ cient SSNs to protect the poor and vulnerable in

cost-effective ways. In transitioning from costly generalized subsidies to

targeted forms of social protection, countries should increase their

spending on existing safety net programs and improve their coverage;

consolidate existing, fragmented SSNs; prioritize interventions such as

conditional cash transfers that strengthen human capital; invest in SSN

infrastructure such as uniﬁ ed registries for beneﬁ ciaries; increase the use

of modern targeting techniques; strengthen governance and accountability

in SSNs; and step up communication to potential beneﬁ ciaries about the

programs available to them.

The complexity of all these tasks requires careful prioritization and

sequencing. Although countries differ in their starting conditions and will

need to tailor their individual reform plans, the scope for macroeconomic

and structural policies to support growth and maintain stability is substantial

in all of them. At the same time, the political transitions are at differing

stages among the ACTs, and in some countries transitional governments with

short horizons and limited mandates have less room to maneuver when

setting in motion the necessary policy reforms. In addition, the administrative

capacity to execute reforms differs among countries and is limited in some

of them. Careful prioritization and sequencing of reforms is thus required

to make efﬁ cient use of political capital and administrative capacity, and the

complexity of the political transitions requires a ﬂ exible approach so that

opportunities for reform can be seized as they arise. It will also be critical to

identify those measures that can be taken quickly to produce strong effects,

such as streamlining business regulation and improving the transparency

of the budget process. Enacting this type of reform quickly would help

strengthen conﬁ dence in the authorities’ commitment to the reform process.

In an evolving sociopolitical environment, careful consideration of political

economy has become crucial. Complex political processes, transition

governments with short horizons, the emergence of new stakeholders,

the growing importance of social media in the political process, increasing

polarization of society, and a difﬁ cult security environment make for

challenging and uncharted territory. To set in motion a virtuous circle where

political transition and economic transformation reinforce one another to

generate higher conﬁ dence and higher growth, policymakers need to employ a

participatory approach, engaging with different segments of society, creating

a sense of urgency for reform and showcasing its beneﬁ ts, listening to

stakeholders’ views, and building coalitions for reform. Policy plans also

Introduction and Summary

need to include effective communication plans. Governments must be able to

explain persuasively the reasoning behind difﬁ cult decisions if people are to

support them.

Stepped-up support from the international community will also be

critical. Even as countries need to stay in the driver’s seat and plan their

policy programs through wide national consultation, there is a need for

the international community to support the ACTs’ policy efforts along

four dimensions. Bilateral and multilateral partners will need to continue

providing signiﬁ cant ﬁ nancing, increasing the scale in some cases, so that

public spending can support growth and, where necessary, ease the pace of

adjustment. Access for the ACTs’ exports to advanced economies’ markets is

also important, to support the economic recovery and raise potential growth.

The ACTs can also proﬁ t from policy advice from their international partners

in many areas of economic policy. In addition, the international community

can help in capacity-building efforts by providing technical assistance and

training.

The IMF remains closely engaged with the ACTs. IMF staff are engaging

with country authorities and their international partners in the areas of

economic policies, ﬁ nancing, and capacity building. The IMF has committed

about $10 billion in ﬁ nancial arrangements with Jordan, Morocco, Tunisia,

and Yemen. IMF staff are in discussions with Yemen toward a successor

arrangement to the IMF support in 2012, and are supporting Egypt and Libya

through policy dialogue and capacity-building efforts.

This paper lays out key elements of reform in the area of economic policy

for the ACTs. While individual countries will design speciﬁ c reform programs

based on their starting positions and reform goals, a number of reform

areas will be common for them. This paper discusses shared priorities and

lessons. Chapter 2 highlights policies to address the ﬁ scal challenges, while

Chap ter 3 discusses aspects of monetary and exchange rate policies to

support near-term stabilization and stable medium-term growth. Chapter 4

raises issues related to ﬁ nancial sector policies for stability and development,

including improving access to ﬁ nance so as to catalyze inclusive growth.

Chapter 5 emphasizes a broad range of areas where economic reform could

generate higher potential growth and improved job creation in the medium

term. Chapter 6 focuses on important supporting factors that need to fall in

place to enhance the chances of successful policy outcomes. These include

the crucial areas of political economy, communication, and support from the

international community.

CHAPTER

Tackling Fiscal Challenges

The ACTs faced signiﬁ cant medium-term ﬁ scal challenges even before the

onset of their transitions. In many cases, ﬁ scal deﬁ cits and debt were higher

than in other emerging market and developing countries, reﬂ ecting, to varying

degrees, generalized food and fuel subsidies, high global commodities prices,

low taxation, and countercyclical ﬁ scal action in the context of the global

ﬁ nancial crisis. Expenditures were dominated by rigid spending on wages and

subsidies, consuming 40 percent or more of most ACTs’ budgets and leaving

too little space for capital expenditures, which in some cases ran at half the

average of emerging and developing economies. Following the global ﬁ nancial

crisis, all ACTs (except Libya) already had high or rising debt levels.

Spending hikes in the aftermath of the Arab Spring further raised ﬁ scal

deﬁ cits and public debt ( Figure 2.1 ). ACT governments attempted to address

pressing social needs and political tensions, and to sustain aggregate demand

by further raising public wage bills and generalized subsidies ( Figure 2.2 ).

In Egypt and Jordan, already sizeable deﬁ cits increased sharply, lifting debt

above 80 percent of GDP by 2013. Despite moderate debt ratios in Morocco,

Tunisia, and Yemen, ﬁ scal vulnerabilities were heightened by elevated

deﬁ cits. Libya’s non-oil ﬁ scal deﬁ cit is close to 170 percent of GDP, the ﬁ scal

breakeven oil price is $118 per barrel,

and the overall ﬁ scal position returned

to a deﬁ cit in 2013 as a consequence of renewed oil supply disruptions,

despite large oil reserves.

At the same time, these spending hikes failed to provide a lasting stimulus

to private sector activity. Raising generalized subsidies and public sector

wage bills provided a temporary boost to consumption but was ineffective

at stimulating the private investment needed to generate jobs and improve

living standards. Moreover, this new current spending was partially offset by

reductions in already low capital spending, and sometimes, also, by reductions

In Jordan, fiscal deficits also worsened because of quasi-fiscal activities and shortfalls in gas from Egypt, which

necessitated expensive fuel imports for electricity generation.

The fiscal breakeven oil price is the hypothetical price of oil at which an oil-exporting country’s budget would be balanced.

Tackling Fiscal Challenges

in maintenance, education, and health spending—all of which are integral to

sustained improvements in private sector activity. While weak demand has also

been a factor in explaining subdued credit growth, ﬁ nancing of the resulting

large ﬁ scal deﬁ cits may be further hampering the recovery, by increasing the

cost of credit available for private sector activities and creating inﬂ ationary

pressures ( Figure 2.3 ).

Figure 2.1 . Fiscal Positions Have Deteriorated

( Gross public debt and overall fiscal balance, average ; percent of GDP)

EGY

JOR

MAR

YMN

TUN

100

–16 –14 –12 –10 –8 –6 –4 –2 0

Public debt

Fiscal balance

2008–10

2013

Sources: National authorities; and IMF staff estimates.

Figure 2.2 . Subsidies, Transfers, and Wages Were Raised

(Changes in revenue and expenditure, 2010–13; percent of GDP)

–10

–8

–6

–4

–2

Egypt Jordan Libya Morocco Tunisia Yemen

Other expenditures

Capital expenditures

Subsidies and transfers

Wages

Total expenditures

Total revenues

–15

Sources: National authorities; and IMF staff estimates.

TOWARD NEW HORIZONS

Figure 2.3 . Crowding Out of Private Sector Credit, 2010–13

DJI

EGY

JOR

LBN

MRT

MAR

PAK

SDN

TUN

WBG

–10

–5

–5 0 5 10 15 20

Change in credit to government

(Percent of GDP)

Change in credit to private sector

(Percent of GDP)

DJI

EGY

JOR

LBN

MRT

MAR

PAK

SDN

TUN

WBG

100

120

140

0 20 40 60 80 100 120 140

Growth in bank deposits

(Percent)

Growth in credit to central government

(Percent)

Source: National authorities; and IMF staff estimates.

In this environment, the demands on near- and medium-term ﬁ scal policy are

substantial. Countries need to carefully reorient and sequence their near-term

policies, so that they are aimed at supporting growth and job creation within

binding resource constraints. Medium-term policies need to aim at clearly

anchoring ﬁ scal stability and strengthening efﬁ ciency.

Demands on near-term ﬁ scal policy call for a reorientation of public

spending toward growth-enhancing and job-creating public investment that

stimulates private sector activity, and toward well-targeted social assistance

that protects vulnerable groups. Room for expansionary ﬁ scal policy is

limited, given already high ﬁ scal imbalances and ﬁ nancing limitations

( Figure 2.4 ). Yet, with weak private sector conﬁ dence, governments have to

take a lead role in shoring up economic activity in the near term. Achieving

this objective without raising deﬁ cits and debt to unsustainable levels requires

mobilizing revenues and cutting current spending, which, for most ACTs,

means reducing spending on generalized subsidies and containing public

sector wage bills.

Although this approach is politically difﬁ cult, the risks to near-term economic

activity appear limited. In emerging and developing countries,

including the

ACTs, ﬁ scal multipliers on current spending are smaller than those on capital

spending; cuts to current spending, therefore, pose less risk to near-term

economic activity. The pace of spending cuts should be designed to contain

the negative effects on growth, as these effects are ampliﬁ ed when output

Ilzetzki, Mendoza, and Vegh (2011).

Tackling Fiscal Challenges

Figure 2.4 . Government Finances

(Percent of GDP)

–15

–10

–5

EGY JOR MAR YMN TUN LBY

General Government Balance

100

EGY JOR MAR YMN TUN LBY

General Government Debt

MAR TUN JOR EGY YMN LBY

Total Tax Revenue

LBY TUN EGY MAR YMN JOR

Total Expenditure

100

MAR 00–09

MAR 10–13

TUN 00–09

TUN 10–13

JOR 00–09

JOR 10–13

EGY 00–09

EGY 10–13

YMN 00–09

YMN 10–13

LBY 00–09

LBY 10–13

Expenditure Components

LBY JOR TUN MAR YMN EGY

Public Investment

2000–09

2010–13

EMDC 2000–09

EMDC 2010–13

2000–09

2010–13

EMDC 2000–09

EMDC 2010–13

2000–09

2010–13

EMDC 2000–09

EMDC 2010–13

2000–09

2010–13

EMDC 2000–09

EMDC 2010–13

2000–09

2010–13

EMDC 2000–09

EMDC 2010–13

Capital

Other Current

Subsidies and Transfers

Wages

Sources: National authorities; and IMF staff estimates.

Note: EMDC = emerging market and developing countries.

TOWARD NEW HORIZONS

Fiscal multipliers are defined as the ratio of a change in output to an exogenous change in government

spending or tax revenues. Several recent studies, including Auerbach and Gorodnichenko (2012) and Baum,

Poplawski-Ribeiro, and Weber (2012) find that fiscal multipliers are magnified in advanced economies when

output is below potential. This also holds for the ACTs, though revenue multipliers are estimated to be less

sensitive to output gaps.

is below potential (the current cyclical position of the ACTs).

In addition,

low tax revenues (relative to GDP) in most ACTs, combined with revenue

multipliers that tend to be lower than expenditure multipliers, support

immediate revenue mobilization. Appropriately chosen near-term revenue

measures—including broadening tax bases, raising income tax progressivity,

and increasing excise and property tax rates—would also improve the

redistributive impact of ﬁ scal policy, which has so far been limited by

weak taxation (see Section B below). This ﬁ scal policy mix would need to

be supported by adequate monetary policy, ﬁ nancial sector policies, and

structural reforms ( Chapters 3 – 5 ) to raise growth.

All ACTs need to anchor their short-term policies in strong and credible

medium-term ﬁ scal consolidation, with the speed of adjustment depending

in part on the availability of ﬁ nancing. Medium-term consolidation will be

needed to support conﬁ dence, turn unsustainable debt dynamics around, and

reduce the susceptibility to shocks. The speed of adjustment will depend,

among other factors, on the size of the ﬁ scal imbalances and the availability

of ﬁ nancing. By way of illustration, delaying subsidy reform in the ACTs by

two years would entail a ﬁ scal cost of $8 billion. Raising public investment

in the ACTs by 5 percent of GDP cumulatively over ﬁ ve years would require

$24 billion in ﬁ nancing, while signiﬁ cantly raising growth and employment

( Figure 2.5 ). Stepped-up support from the international community, especially

on budget support, would thus help smooth the adjustment ( Chapter 6 ).

Fiscal consolidation will require signiﬁ cant effort over the medium term.

While countries are at various stages of planning ﬁ scal adjustment, an

illustrative scenario can shed light on the scale of the challenge: if primary

balances were to remain at their current levels, the public debt ratio would rise

by about 17 percent of GDP on average over the next ﬁ ve years and reach

87 percent of GDP. Restoring debt to sustainable levels (assumed here, for

purposes of illustration, at around 40–60 percent of GDP) over the medium

term will require raising the primary ﬁ scal balance by an average of 8 percent

to 10 percent of GDP. Moreover, current account deﬁ cits and ﬁ nancing needs

are substantial in many ACTs. For countries with low ﬁ scal or external buffers,

delays in consolidation could heighten concerns about the sustainability of

macroeconomic policies, further eroding conﬁ dence and impairing growth.

Even in Libya, ﬁ scal vulnerabilities from high breakeven oil prices (highlighted

by the renewed disruptions to oil output), and insufﬁ cient savings to support

spending for future generations call for ﬁ scal consolidation.

Tackling Fiscal Challenges

Medium-term consolidation plans need to center on lower current spending

and higher revenue mobilization. Strategic spending reorientation should

aim at eliminating generalized subsidies, undertaking comprehensive civil

service reforms, and channeling part of these savings toward enhancing the

coverage and amounts of targeted social assistance and strengthening public

investment. The successful implementation of these reforms will also depend

on improvements in key aspects of the budget process. On the revenue

side, medium-term reforms should aim at improving the tax structure, and

increasingly turn to tax and customs administration reforms, which would

not only raise revenues but also improve governance and the business

environment. These policies would improve equity, create jobs, and enhance

long-term growth prospects by boosting productivity.

The success of such ﬁ scal strategies will depend on getting the political economy

right. Policymakers will need to gauge what reforms are possible and how best to

sequence them under difﬁ cult sociopolitical circumstances. Success will depend on

listening to all stakeholders’ views when formulating policy agendas, and building

the coalitions needed to implement them. To this end, the recent tax conference

in Morocco and the ongoing national tax consultation process in Tunisia have

been useful in building consensus for tax reforms. It will be important to know

who stands to lose as a result of reform—whether in certain regions or economic

sectors or along demographic or income lines. Such knowledge can help

predict opposition to proposed plans and can inform strategies to address such

opposition. A broad-based communication strategy, emphasizing that this form of

consolidation will contain the negative impact on incomes and jobs while possibly

improving income distribution, will be critical to building political consensus and

gaining the public support needed to sustain the consolidation effort.

Figure 2.5. A 5 Percent of GDP Increase in Public Investment Would Significantly

Impact Growth and Employment

2008 09 10 11 12 13 14 15 16 17 18 19 20

GDP Growth

(Percent)

5 percent

of GDP

Baseline

Projecon

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

2012 13 14 15 16 17

Job Creaon

(Million)

Source: National authorities; and IMF staff estimates.

ACTs, excluding Libya.

Under various employment elasticities.

TOWARD NEW HORIZONS

Reorienting Spending

Increased spending on public wage bills and generalized subsidies, in response

to social pressures, stimulated near-term economic activity, but also widened

external imbalances and worsened inequalities and expenditure rigidities.

Broad-based subsidies, especially for energy, support imports more than they

support demand for domestic goods and services, and they disproportionately

beneﬁ t high-income segments of the population, who consume large

amounts of fuel and electricity. Consequently, the bulk of subsidy increases

was transferred to the wealthy and had limited effect in generating jobs or

improving the living standards of the average household. Hikes in public wage

bills were introduced in a difﬁ cult sociopolitical context; their continuation is

not a sustainable policy option ( Figure 2.6 ). They also tend to raise inequality

(IMF, 2012c), especially where government employees hold an above-average

position in the income distribution ( Figure 2.7 ). Recognizing the limitations of

cross-country comparisons in this area, among the ACTs, income inequality

is highest in Tunisia and Morocco, where average civil service wages are three

and four times per capita GDP, respectively. Expenditure rigidities stemming

from the public wage bill and generalized subsidies, both above emerging and

developing country averages, create additional challenges for ﬁ scal policy.

Carefully reorienting public spending away from generalized subsidies

towards targeted social safety nets would support poorer households,

reduce inequalities, and free resources for priority expenditure and deﬁ cit

reduction. Stable or declining international energy prices have created

a window of opportunity for reform of energy subsidies. Given the

delicate sociopolitical environment, cuts in subsidies should be gradual and

implemented concurrently with increased targeted social assistance (including

Figure 2.6 . High Public Wage Bills

(Employee compensation, 2012; percent of GDP)

LBY MAR TUN YEM EGY JOR

Emerging Market and

Developing Countries Average

Sources: National authorities; and IMF staff estimates.

Tackling Fiscal Challenges

See: IMF, 2013b for more details.

Automatic pricing should include price-smoothing measures to avoid potentially large fluctuations in domestic

fuel prices.

Figure 2.7 . High Public Wages Tend to Raise Inequality

DZA

ARM

AZE

DJI

EGY

GEO

IRN

IRQ

JOR

KAZ

KGZ

MRT

MAR

QAT

SDN

SYR

TJK

TUN

TKM

UZB

YEM

0 1020304050

GINI coeﬃcient, latest available

Public wages (average 2007–12)

in percent of total expenditure

Public Wages and Inequality

Sources: National authorities; World Bank World

Development Indicators; and IMF staff calculations.

Egypt

Jordan

Tunisia

Morocco

Africa

Asia

Europe

Lan America

1.0

2.5

2.8

3.9

1.3

1.4

Average Public Administraon Wage

(Percent of per capita GDP)

Sources: National authorities; and IMF staff

calculations.

1. Annual average for 2000-08, except for Jordan,

Morocco, and Tunisia, where data are for 2009.

targeted cash transfers or vouchers) to mitigate the effects on poor and

vulnerable households (see Chapter 5 ). To that end, Jordan is gradually raising

electricity tariffs, has eliminated fuel subsidies, introduced a monthly fuel

price adjustment mechanism, and reallocated some of the savings from these

reforms to the bottom 70 percent of households via cash transfers ( going

well beyond compensation for the poor, also strengthening buy-in from the

middle class, though the eligibility criteria are being ﬁ ne-tuned with a view to

better targeting the poor segments of the population). Energy price increases

have also been implemented in Morocco, Tunisia, and Yemen. To a lesser

extent, reforms have also begun in Egypt (IMF 2013d, Box 2.4 provides details).

Instituting energy subsidy reform is politically difﬁ cult, and country

experiences provide key lessons for success.

Important elements are a

comprehensive energy sector reform plan that includes consultation with the

main stakeholders; appropriately phased energy price increases; introduction

of automatic pricing mechanisms

to depoliticize energy pricing; a plan to

improve the efﬁ ciency of state-owned enterprises and utilities to reduce

producer subsidies; targeted measures to compensate and protect the

poor and vulnerable; and an extensive communications strategy, including

TOWARD NEW HORIZONS

publication of the magnitude of existing subsidies and planned use of

prospective ﬁ scal savings. Opinion polls have shown, for example, that

citizens tend to support subsidy reform if they perceive that the proceeds

are used for pro-poor, education, and health spending, and if they can be

satisﬁ ed that these expenditures are done in an efﬁ cient way ( Box 2.1 ).

Box 2.1. Mixed Public Views on Cutting Energy Subsidies

ACT populations are coming to terms with the need for subsidy reform, in recognition

of rising ﬁ scal pressures. Several ACT governments have recently taken steps toward

cutting back costly generalized subsidies, especially for energy. Generally, populations

have accepted these changes, but they do hold strong opinions on the types of subsidies

that should be cut and where the savings should be allocated. A recent poll of ACT

populations, conducted for the World Bank,

provides more insight into their views.

Cuts in fuel subsidies are preferred over cuts to food subsidies (Table 2.1.1). In Tunisia

40 percent of respondents favored cutting energy subsidies. The response was not

as strong in Egypt and Jordan, at 30 percent, but support for the removal of energy

subsidies was several times stronger than for removal of food subsidies. This difference

may reﬂ ect populations’ awareness that fuel subsidies disproportionately beneﬁ t the

wealthy. The poll results also indicate that Tunisians are least likely to oppose large-

scale subsidy reform, while 60 percent of respondents in Egypt and nearly half of

respondents in Jordan were not in favor of subsidy removal.

Distributing savings to poor households and improving social services is favored,

and can improve the public buy-in for reform. At least half the respondents in Egypt

and Tunisia speciﬁ ed that the savings from energy subsidies should be distributed

as cash transfers to the poor and as increased spending on healthcare and education

Table 2.1.1. Subsidy Removal Preferences

(Percent of respondents)

Egypt Jordan Tunisia

Energy 31 28 41

Food 6 13 25

None 60 47 27

No response 3 12 7

Source: World Bank MENA Development Report, “Inclusion and

Resilience: The Way Forward for Social Safety Nets in the Middle

East and North Africa.”

Response to the question, “If the government had to remove

subsdies, which products would you prefer they target?”

A Gallup poll of 4,000 interviews with adults, aged 15 and older, was conducted in Egypt, Jordan, Lebanon,

and Tunisia during September–December 2012.

Tackling Fiscal Challenges

(Table 2.1.2). Notably, more than two-thirds of Tunisians and nearly 60 percent

of Egyptians who opposed any subsidy removal when originally asked indicated

subsequently that they would support removing diesel subsidies if the savings were to

be distributed to the poor and to education and healthcare spending.

Morocco undertook successful reforms to downsize its public sector in 2005. However, further reforms are

needed to raise the productivity of its civil service. In Yemen, the cabinet recently approved a plan to eliminate

ghost workers and double-dippers in the civil service and military and security forces.

Table 2.1.2. Preferences for Distribution of Savings from Energy Subsidies

(Percent of respondents)

Distribute savings to . . . Egypt Jordan Tunisia

Poorest households 32 50 38

All except wealthy households 3 19 6

All households 2 3 1

Healthcare and education as well as poorest households 57 10 50

No response 7 19 4

Source: World Bank MENA Development Report, “Inclusion and Resilience: The Way Forward for Social

Safety Nets in the Middle East and North Africa.”

Response to the question, “Where should the government spend the savings from energy subsidies?”

Box 2.1 (concluded)

Containing public wage bills would reduce expenditure rigidities and support

ﬁ scal strategies for sustainability and private sector job creation. Using the

public sector as employer of ﬁ rst and last resort is no longer an option where

ﬁ scal buffers are running low. Moreover, in some cases inﬂ ated public sector

salaries reduce the appeal of private sector jobs for the best workers. To

kick-start reforms and facilitate private sector growth, further public sector

hiring should be strictly limited and real wage growth should be reduced by

restraining the growth of nominal wages and allowances, and by streamlining

bonuses. Near-term consolidation efforts can be complemented by medium-

term plans for comprehensive civil service reforms that review the size and

structure (including regional and functional allocations) of the civil service

to create a skilled and efﬁ cient government work force. This would entail

reviewing existing civil service legislation and regulations to rationalize

compensation policies, improve retention, and to create stronger performance

incentives by tightening the link between pay and performance. At the same

time, strengthening the payroll system would help eliminate ghost workers and

double-dippers, especially in Libya and Yemen.

TOWARD NEW HORIZONS

Empirical literature finds that education is one of the main determinants of cross-country variations in

inequality (De Gregorio and Lee, 2002; IMF, 2007; and Barro, 2008).

Increasing growth-enhancing capital expenditures will be important.

Increasing outlays on efﬁ cient capital projects, healthcare, education, and

training—particularly for low- and middle-income households—would create

jobs and reduce inequalities

in the near term, while strengthening long-term

growth prospects.

The quality and efﬁ ciency of all growth-enhancing spending will need to be

monitored, and implementation capacity strengthened ( Figure 2.8 ). Public-

private partnerships (PPPs) in a variety of areas can lessen the burden on public

budgets, but only where the political environment supports them and where

strong PPP legal frameworks and mechanisms can be established to mitigate

the risk of large contingent liabilities. Strengthened reporting and monitoring

mechanisms, as well as procurement systems, are essential for improvements

in this phase, in both government and public enterprises, and would support

a better business environment. Appropriate vetting and prioritization systems

(i.e., choosing projects that relieve infrastructure bottlenecks, complement

private investment, and enhance productivity), timely allocation of recurrent

expenditures, and ex-post evaluations and internal audits would underpin

improvements in the appraisal, selection, and project evaluation stages.

Broad public ﬁ nancial management reforms would bolster implementation

of the plans above and instill conﬁ dence in ACT governments’ commitment

Figure 2.8 . Large Variation in the Quality of Public Investment Management

(Public investment managment index; 0 (lowest) to 4 (highest) )

Source: Dabla-Norris and others (2011).

TUN JOR EGY YEM LAC EM

Europe

MCD Dev.

Asia

Africa

Appraisal Score

Implementaon Score

Selecon Score

Evaluaon Score

Tackling Fiscal Challenges

to ﬁ scal sustainability and good governance. Improvements are needed across

key aspects of the budget process, including, ﬁ rst and foremost, commitment

controls and strengthened systems for budget preparation, as well as

enhancements to budget coverage and audit:

•

Better commitment controls

are essential to limit the possibility

of expenditure overruns, which is especially important for the ACTs in

light of a history of overruns and substantial near- and medium-term

consolidation needs. The ﬁ rst step toward addressing this challenge will

be for all ACTs to move immediately toward exercising expenditure

controls at the point of expenditure commitment rather than at the

payment stage. Implementing efﬁ cient technological platforms such

as Integrated Financial Management Information Systems (IFMIS)

will be an important part of the process of improving cash and debt

management. Allocating an appropriate level of contingency reserves

would also help governments adjust to unexpected revenue declines or

spending needs.

•

Sound budget preparation

is equally important: it enhances policy

prioritization, which is key for the ACTs, given their need to prioritize

spending in the context of limited resources. Approaches vary across

the ACTs, from top-down in Jordan and Yemen to bottom-up in Egypt.

International best practices indicate that all the ACTs would beneﬁ t from

adopting a top-down approach that is complemented by strong ties between

macro-ﬁ scal projections and the budget, a uniﬁ ed budget process (that

is, full integration of recurrent and capital budgets), and a closely linked

medium-term ﬁ scal framework. This approach should be complemented by

bottom-up performance-based budgets at the sectoral level.

•

Comprehensive budget coverage and increased transparency

are

needed to be able to adequately assess the ﬁ scal stance and rein in extra-

budgetary spending. Budget coverage in the ACTs tends to be narrower

than in other regions (see IMF, 2013c, Box 2.5 ). Coverage that includes

public enterprises, social security and pension funds, along with broad

budget reporting that encompasses functional classiﬁ cations, contingent

liabilities, and arrears, would enhance transparency and risk assessment.

This would rein in the use of third-party revenues and unused budget

allocations for extra-budgetary expenditures, support the tracking of

poverty-reducing expenditures, and facilitate the analysis of the allocation

of resources across sectors. A statement of ﬁ scal risks as part of the

budget documents would also strengthen transparency. Disclosure of

budget documents and outcomes would help strengthen accountability.

•

Strong internal and external audit procedures

are essential to

implementing ﬁ nancial controls and risk management, thereby

TOWARD NEW HORIZONS

strengthening governance. Morocco has made good progress in this

area, but there is ample scope for strengthening such procedures in other

ACTs. International best practices indicate that the ACTs should strive

for independent auditors with clearly deﬁ ned functional and institutional

roles, sufﬁ cient access to information, and the power to report to the

appropriate authorities.

For ACTs that have embarked on decentralization, potential ﬁ scal risks

should be limited with a sound intergovernmental ﬁ scal relations framework.

Efforts in most ACTs to embark on decentralization pre-date the political

transitions that started in 2011, though decentralization endeavors are now

inﬂ uenced and shaped in part by the transitions. Except for Morocco, the

ACTs are still in the early stages of decentralization ( Box 2.2 ). Before moving

forward, it will be important for these countries to strengthen their public

ﬁ nancial management along the lines suggested above: clarify expenditure

assignments, transfer and equalization systems, and build capacity at the

level of sub-national governments. This includes appropriate sequencing

of resources across sub-national governments (e.g., ex ante deﬁ nition of

the resource envelope for sub-nationals) in line with the assignment of

spending responsibilities and limits on sub-national borrowing to avoid

excessive borrowing and ensure ﬁ scal discipline. The pace of decentralization

should depend on the capacity of sub-national governments to carry out

their assigned functions, which in turn relies on the strength of their public

ﬁ nancial management. Finally, development of effective intergovernmental

transfer systems should offset vertical and horizontal imbalances across

various levels of government.

Mobilizing Revenues

Weak tax structures in many ACTs limit tax revenues and foster inequalities.

In these cases, revenues have persistently suffered from weak collection,

largely the result of high tax exemptions and compliance issues, and, in some

countries, low income and corporate tax rates compared to those in other

emerging and developing countries. The tax effort is generally well below

100 percent in the ACTs (except Morocco), implying that the gap between

actual and potential tax revenue collection is substantial ( Table 2.1 ).

This

ﬁ nding is robust to various measures of potential revenue: these include

comparing a country’s tax receipts with: (i) the average of its peers, controlling

The tax effort is measured as actual tax collection in percent of potential tax revenues, estimated by

comparing a country’s tax receipts with those of peers with similar characteristics.

Tackling Fiscal Challenges

Box 2.2. Progress on Decentralization

Jordan is in the initial stages of decentralization. A draft Local Councils

Law, focused on administrative reforms, was prepared in 2010, but budgetary

and financial management aspects of the law are relatively limited. Several

parameters of reform have yet to be clarified: the link between governorates’

and national priorities; mechanisms for deciding the allocation of resources to

each governorate; the link between capital projects in the governorates and the

recurrent expenditures needed to operate the projects (on line ministry budgets);

and the link between new policies and governorates’ development of financial

management capacity.

In Morocco, regions already have some autonomy while also receiving transfers

from the central government; however, resource distribution across regions involves

a cumbersome process that generates regional disparities. In January 2010, to address

these challenges, the King appointed the Consultative Commission for Regionalization

(CCR), an advisory committee, to prepare a roadmap for a new model of

decentralization. The CCR proposed a number of important reforms that are currently

under discussion. Some key elements of the reforms include enhancing governance at

the regional level, strengthening regional involvement in implementing development

projects, and improving capacity at the sub-national level by transferring competencies

from the central government to local councils.

Tunisia is moving toward decentralization; key principles have been enshrined in

the recently approved constitution. Progress in decentralization so far has been slow:

there have been no major changes in expenditure assignments; governorates continue

to exercise tight control of municipalities; and governors (executive heads of the

governorates, appointed by the President) are still reporting to the Ministry of the

Interior. Devolution of public services is more advanced: in the education, health,

and agricultural sectors, a growing share of the budget is implemented by legally

autonomous entities (Etablissements Publics Administratifs). Nevertheless, their operational

autonomy for personnel management and procurement can still be increased.

In Yemen, the Ministry of Local Administration (MOLA) paved the way for

decentralization with amendments to the Decentralization Act and the Decentralization

Strategy; however, progress has been held back by capacity constraints at the

governorates and slow implementation of important public ﬁ nancial management

reforms. The shape of future federal arrangements, including those related to

decentralization issues, is currently under discussion.

for a range of characteristics likely to affect the ability to raise revenue, such

as per capita income (see regression analysis in Box 2.3 ); or (ii) the maximum

that others with similar characteristics have achieved (stochastic frontier

TOWARD NEW HORIZONS

Table 2.1 . Room for Improvement in Tax Effort and VAT Collection Efficiency

Tax Effort

VAT Collection Efficiency

Regression Analysis, Box

Stochastic Frontier Analysis

Jordan 51 64 74

Egypt 73 72 . . .

Morocco 95 93 72

Tunisia 91 . . . 53

Yemen . . . 73 . . .

Sources: National authorities; IMF 2013c; and IMF staff estimates.

2012.

Based on IMF 2013c, Appendix 2.

Average for emerging markets with most comparable characteristics to the ACTs.

Figure 2.9 . Scope for Additional Revenue Collection

(Tax rates and revenue, 2012

)

Sources: National authorities; KPMG; Deloitte; and IMF staff calculations.

Or latest available data.

Goods and Services

Income

Trade

Other

MAR TUN EGY YEM JOR LBY

Top Tier Personal Income Tax Rates

(Percent)

MAR TUN EGY YEM LBY JOR

Top Tier Corporate Income Tax Rates

(Percent)

100

120

JOR MAR EGY YEM TUN LBY EMDC

EMDC Average EMDC Average

Tax Revenue Components

(Percent of Total Revenue)

Tackling Fiscal Challenges

analysis). Similarly, the ACTs’ value-added (VAT) collection efﬁ ciency is low

relative to the 80 percent average of emerging and developing economies.

Tax progressivity is also low in most ACTs. In the non-oil ACTs the lack of

progressivity largely reﬂ ects reliance on goods and services taxes and limited

progressive income taxation. Absent change in the tax structure, these revenue

challenges are expected to persist in the medium term in Egypt, Jordan, and

Tunisia. In Yemen and Libya, the risk of declining oil prices underlines the

importance of developing their non-oil sectors to create jobs, diversify growth,

and develop a tax base that can supplement oil-related income over time.

Raising additional revenue is a priority for the ACTs ( Figure 2.9 ). Low tax

revenue intake suggests the potential for additional collection, while revenue

multipliers that are smaller than the multipliers on the expenditure side

imply that revenue generation is a less costly means—in terms of growth

impact—of providing additional ﬁ scal space than expenditure cuts. Collecting

additional revenue can thus generate ﬁ scal resources for priority expenditure

and deﬁ cit reduction, without a high cost in growth and jobs.

Revenue gap analysis suggests country-speciﬁ c areas where revenue measures can

raise yields and support growth, equity, and competitiveness. Revenue gap analysis

is applied to guide the focus of efforts to improve tax yields ( Box 2.3 ). Egypt and

Tunisia, in particular, have scope for measures that would improve yields from

consumption taxes, the main area in which they fall short of their tax potential.

Jordan could substantially raise its revenue potential by focusing on income tax

collection; a draft income tax law, aiming to increase rates for individuals and

corporates, was submitted to Parliament in February 2014. Even Morocco,

with tax revenues close to potential, would beneﬁ t from greater efﬁ ciency in tax

collection. To reduce their reliance on oil revenues, Yemen and Libya need to

build their non-oil revenues across consumption, income, and other taxes. Some

key initial tax policy measures that will help the ACTs raise revenues while meeting

other macroeconomic and equity considerations include broadening the tax base,

introducing greater income tax progressivity, and raising excise and property tax rates.

Broadening the tax base promotes several macroeconomic and equity objectives.

It fosters equity, especially compared to across-the-board rate increases which can

be both regressive (particularly for income and consumption taxes) and politically

challenging to implement. New evidence conﬁ rms that base broadening is also

better for growth—especially for VAT (Acosta-Ormachea and Yoo, 2013)—and

for improving the business environment. Consequently, tax exemptions and

deductions (except those protecting the poor) should be heavily reduced for all

taxes and, whenever possible, multiple VAT rates consolidated into a single rate

while raising registration thresholds ( Table 2.2 ). Some progress has been made

with the introduction of taxes on large agricultural ﬁ rms in Morocco and moves

toward harmonization of onshore and offshore taxation in Tunisia (including a

reduction of the onshore income tax rate). More broadly, reducing tax exemptions

would also reduce tax administration and compliance costs as well as tax evasion.

TOWARD NEW HORIZONS

Box 2.3. Tax Potential and Revenue Gaps in Non-Oil ACTs

Revenue gaps, the difference between actual tax revenues and estimates of

their potential, highlight areas where ACTs can garner further tax revenues.

In any country, tax potential depends on characteristics that are likely to affect its

revenue-raising ability—economic (such as its level of development, or revenue from

other sources), political (including constitutional), and even geographical (revenues

can be harder to raise when borders are long and porous). Consequently, tax potential

can be estimated by comparing a country’s tax receipts with the average of its peers,

controlling for economic characteristics (Table 2.3.1). By construction, some countries

will have revenue above this average, and others will have revenue below. Libya and

Yemen are excluded from the analysis because they rely mainly on oil revenues.

The domestic tax potential of non-oil ACTs varies greatly.

Applying a novel

dataset of 66 middle-income and emerging economies from Torres (2014), tax potential

is assessed separately for consumption and for other taxes. Controlling for differences in

per capita gross national income, VAT or GST rates, top tier corporate income tax rate,

the redistribution of tax revenues (proxied by social spending and direct subsidies),

and the current business cycle position (proxied by the gap between the current GDP

growth rate and its potential), the following ﬁ ndings emerge (Figure 2.3.1):

Table 2.3.1. Determinants of Tax Revenues

(Percent of GDP)

Total domestic tax Consumption tax

Per capita GNI 1.75*** 0.82***

VAT rate 0.33* 0.21*

Corporate Income tax rate

0.04

. . .

Social spending 0.70*** 0.22***

Growth gap 0.51*** 0.19*

Constant 8.75** 3.85***

Number of countries 64 66

Adjusted R-squared 0.69 0.42

***, **, *: statistically significant at 1, 5, and 10 percent.

Sources: National authorities; and IMF staff estimates.

Includes VAT and excises.

Because international trade taxes have experienced a declining trend in the ACTs with the lowering of

international trade barriers, this analysis focuses on domestic taxes—defined as the total collection of taxes less

international trade taxes.

Per capita gross national income is highly correlated with the VAT, corporate income tax rates, and social

spending. Consequently, the regression applies these variables after they have been purged of their correlation

with per capita gross national income.

Tackling Fiscal Challenges

• Jordan is lagging behind its peers in raising tax revenues. Compared to countries

with similar tax rates, its collection is especially low for income, property, and

excise taxes.

• In Egypt there is some scope for improving collection of all taxes. In particular, GST

collection is especially low because of numerous exemptions.

• Tunisia stands to gain from greater consumption tax revenues, which have also been

eroded by exemptions; however, it exceeds its peers in the collection of other taxes.

• Overall, Morocco’s tax collection is already comparable to its peers. It slightly

outperforms peers in consumption taxes, but further gains could be achieved in other

taxes.

In light of these results, broadening the tax base and improving tax administration will

be key elements of reform across the non-oil ACTs. For those lagging in collection of

non-consumption taxes, special attention should also be paid to increasing progressivity

of income taxes and ramping up property taxes.

Box 2.3 (concluded)

Figure 2.3.1. Potential Tax Revenue Gains

1,2

(Percent of GDP)

Sources: National authorities; and IMF staff estimates.

Model-based estimated tax revenues minus actual tax revenues;

often referred to as tax gap.

Other taxes include income, excise, and property taxes.

–6.0

–3.0

0.0

3.0

6.0

9.0

12.0

15.0

Jordan Egypt Tunisia Morocco

Other taxes

Consumpon tax

Total

TOWARD NEW HORIZONS

Table 2.2 . Non-Oil ACTs: Base Broadening Recommendations

Egypt Multiple general sales tax (GST) and corporate income tax (CIT) rates could be unified, GST

extended to services, personal income tax (PIT) extended to all forms of capital income, and

discretionary power over customs exemptions eliminated.

Jordan GST thresholds could be harmonized, capital gains taxes instituted, and the exemption threshold

under the PIT lowered.

Morocco Numerous VAT rates could be reduced.

Tunisia A single CIT rate could be applied for on- and off-shore activities, and corporate dividends taxed.

Efforts to reduce the large informal sector (see Chapter 5 ) would also enlarge

the tax base. A solid communication strategy—for example, Morocco’s current

practice of publishing an annual tax expenditure review highlighting costs and

beneﬁ ts—would be critical to facilitate public buy-in for these efforts.

Greater income tax progressivity, in some ACTs, would improve equity,

with little impact on growth. Except in Morocco and Tunisia, income tax

progressivity in the ACTs is low ( Table 2.3 ). Recently, progressivity has been

increased in Egypt by the introduction of a new income tax bracket for high

income earners and raising the rate applied to them. In Jordan, Libya, and

Yemen, greater personal income tax progressivity could entail introducing a

higher rate for the highest income earners, preserving the current rates for

the majority of the population and lowering the rate for the lowest income

segments of the population. In China, for example, greater progressivity was

introduced by reducing the starting rate and widening the band over which the

top rate applies (IMF 2013c). Greater tax progressivity is envisaged in Jordan’s

draft income tax law, which proposes an increase in the top personal income

tax rate (reversing a 2009 rate cut).

Multiple objectives could also be achieved by raising excise and property tax

rates ( Figure 2.10 ). In light of their currently low levels in a number of ACTs,

higher rates on luxury goods’ excises, and on taxes on high-value properties,

would improve revenues, efﬁ ciency, and fairness, with limited effects on

growth; these taxes would mostly affect the wealthy, who typically have a

relatively low consumption elasticity. Implementation of property taxes,

however, would require substantial upfront investment in administrative

infrastructure that would include establishing a comprehensive cadastre,

valuation mechanisms, and effective enforcement.

These tax policy efforts should be complemented by reforms to tax and customs

administration. Supporting administrative reforms would help generate additional

revenue, help level the playing ﬁ eld by increasing transparency, compliance, and

efﬁ ciency, garner public support for the overall reform package, and promote

foreign direct investment and competitiveness, thus supporting higher medium-

term growth. In light of the ACTs’ need to stimulate private sector conﬁ dence

Tackling Fiscal Challenges

and activity, reforms should target strengthened administrative capacity and

enhanced compliance, to address governance concerns. With these objectives in

mind, it will be important to undertake the following reforms:

• Simplifying tax systems would improve their efﬁ ciency and business-

friendliness. Streamlining procedures and simplifying tax codes, tax

regulations, and small and medium-sized enterprise tax regimes are

critical reforms in this area.

• Enhancing tax compliance is also an important component of

reforms. In Jordan and Morocco, where VAT revenues are large, a risk-

based compliance system (including an automated VAT refunds system)

would raise tax yield, facilitate business operations, and reduce unequal

Table 2.3 . Scope for More Income Tax Progressivity

(Personal income tax brackets in ACTs (local currency) )

Rate ( Percent) Income bracket

Egypt 0 EGP 0–5,000

10 EGP 5,000–30,000

15 EGP 30,000–45,000

20 EGP 45,000–250,000

25 EGP >250,000

Jordan 7 JOD 0–12,000

14 JOD >12,000

Libya 5 LYD 0–12,000

10 LYD >12,000

Morocco 0 MAD 0–30,000

10 MAD 30,000–50,000

20 MAD 50,000–60,000

30 MAD 60,000–80,000

34 MAD 80,000–180,000

38 MAD >180,000

Tunisia 0 TND 0–1,500

15 TND 1,500–5,000

20 TND 5,000–10,000

25 TND 10,000–20,000

30 TND 20,000–50,000

35 TND >50,000

Yemen 12 YER 0–20,000

15 YER >20,000

Sources: National authorities; and Deloitte and Touche, KPMG.

As of end-2012.

TOWARD NEW HORIZONS

tax treatment across companies. International experience also suggests

that a large tax payers’ department, operating through a small number

of ofﬁ ces, can lower tax evasion and improve administrative efﬁ ciency.

For example, in Jordan, tax amnesties could be eliminated, penalties

strengthened, and resources for the large taxpayers’ ofﬁ ce increased.

• Strengthening the capacity of revenue administration will be critical,

and includes the retention of high-quality staff, who are necessary to

successfully implement reforms in this area. In addition, more ﬁ nancial,

technological, and human resources would raise yields and enhance

governance. This is especially important for Yemen, where effective

revenue administration is the key to reversing a culture of low tax

compliance.

• Advancing customs administration reforms would substantially

raise yields on import VAT, excise, and international trade taxes.

A comprehensive reform package in this area should include

(i) information sharing between the tax and customs administrations

through valuation databases that are accessible to internal auditors and

used by ﬁ eld declaration clearance ofﬁ cers to check declared customs

values; (ii) replacing cumbersome customs codes with a simpliﬁ ed code

pooling all customs laws, regulations, and orders; and (iii) reducing large

physical examination requirements and clearance periods.

Figure 2.10 . Scope for Raising Property and Excise Tax Rates

(Property and excise tax revenue, latest available; percent of GDP)

Source: National authorities; and IMF staff estimates.

Latest available data .

Excise taxes are small and classifed under GST or fees.

EMDC Average

OECD Average

EMDC Average

OECD Average

0.5

1.5

2.5

3.5

MAR EGY TUN JOR LBY YEM

Property Tax Revenue

(Percent of GDP

)

0.5

1.5

2.5

3.5

MAR TUN EGY YEM LBY JOR

Excise Tax Revenue

(Percent of GDP)

CHAPTER

Monetary and Exchange Rate Policy

for Stability, Growth, and Jobs

The ACTs’ longstanding monetary and exchange rate policies have

traditionally supported stability, but with pressures building up from time

to time. Most ACTs have historically relied on stable exchange rates as

a nominal anchor for monetary policy. While this generally supported a

benign inﬂ ation environment and economic stability, some countries faced

a gradual erosion of their competitiveness because they had persistently

higher inﬂ ation than their main trading partners. Since the onset of the

transitions in 2011, the setting in which monetary and exchange rate policy

operates has faced further complexities. The transitions have left many

ACTs with signiﬁ cant output gaps and current account deﬁ cits, reduced

inﬂ ows of private capital, and much-diminished ﬁ scal policy space and

external buffers.

Limited exchange rate ﬂ exibility constrains monetary policy options. Stimulus

for higher growth that would enable private sector job creation is urgently

needed, but ﬁ scal policy options are limited because of the need to focus

on ﬁ scal sustainability ( Chapter 2 ). In addition, high ﬁ scal deﬁ cits, largely

ﬁ nanced domestically, have in some cases raised the cost of bank ﬁ nancing

for the private sector. The outlook for higher global interest rates, resulting

from a strengthening recovery in the United States, could further impair

domestic ﬁ nancing conditions, especially in countries with ﬁ xed exchange

rates.

The ongoing political transitions provide an opportunity to rethink monetary

and exchange rate policies. Economic and political changes, in the context

of the ongoing transitions, are providing a new setting for economic policies,

with a view to identifying the right policies for short-term stabilization and

stimulus, as well as for medium-term growth.

TOWARD NEW HORIZONS

The Current Context for Monetary and Exchange Rate Policies

The ACTs are in a difﬁ cult cyclical and external position. The political

transitions since 2011 have been accompanied by economic downturns, leading

to—in some cases substantial—output gaps and deteriorating living standards,

and further raising already high unemployment. External positions have

also deteriorated ( Figure 3.1 , Figure 3.2 ). Chronically large trade and current

account deﬁ cits have doubled since before the transition in some countries.

Rising food and energy import prices, and falling goods and services exports,

owing to security concerns and weak global growth, including the recession

in Europe, have contributed to these increases. At the same time, subdued

conﬁ dence and sovereign credit downgrades reduced capital ﬂ ows in 2011,

and these have only partially recovered.

International reserves have declined substantially. In most cases (except Jordan

and Libya), they now only cover a few months of imports and need to be

increased to get comfortably in the range indicated by the IMF’s reserve

adequacy metric, which calculates an adequate range for reserves for meeting

vulnerabilities to export income, debt repayments, portfolio ﬂ ows, and

potential capital ﬂ ight ( Figure 3.3 ).

Figure 3.1 . Significant Macroeconomic Impacts

from the Political Transitions

–2

100

2007 08 09 10 11 12 13

Reserves (US$ billions), le scale

Current account deﬁcit (% GDP)

Financial ﬂows (% GDP)

Real GDP per capita growth

Sources: National authorities; and IMF staff calculations.

Excludes Libya.

Libya maintains large foreign assets; reserve coverage is not a concern.

Monetary and Exchange Rate Policy for Stability, Growth, and Jobs

Figure 3.2 . External Developments

–3

–10

2007 08 09 10 11 12 13

Egypt

–50

–40

–30

–20

–10

100

120

140

2007 08 09 10 11 1312

Libya

2007 08 09 10 11 12 13

Morocco

2007 08 09 10 11 12 13

Tunisia

–4

–2

2007 08 09 10 11 12 13

Yemen

Reserves (US$ billions), le scale Current account deﬁcit (% GDP), right scale Financial ﬂows (% GDP), right scale

2007 08 09 10 11 12 13

Jordan

Sources: National authorities; and IMF staff calculations.

Note: Financial flows are calculated as net direct investment + net portfolio investment + net other investments.

TOWARD NEW HORIZONS

Figure 3.3 . International Reserves Have Dropped Since the Onset of the Transition

100

150

200

250

300

2004 05 06 07 08 09 10 11 12 13

Egypt Jordan

Morocco Tunisia

Reserve Adequacy

(Reserves as a share of ARA

metric)

Suggested

adequacy range

2008 09 10 11 1312

Egypt Jordan

Morocco Tunisia

Yemen

Gross Internaonal Reserves

(Months of imports)

Source: National authorities; and IMF staff calculations.

Assessing Reserve Adequacy metric as defined in (IMF, 2011a). 2013 estimates based on preliminary data.

I n ﬂ ation outcomes have been, for the most part, benign. Substantial output

gaps, subsidies on imported food and fuel products, and exchange rate

stability relative to an appreciating U.S. dollar have helped keep inﬂ ation in

most ACTs lower than in emerging markets, on average ( Figure 3.4 ). However,

in Egypt inﬂ ation has been structurally high and has risen over the past year as

a result of pass-through from exchange rate depreciation, money expansion,

supply shortages, and recurrent wage increases. Inﬂ ation in Yemen remains

elevated but has declined in the context of the country’s macroeconomic

stabilization efforts following the 2011 crisis. In Jordan headline inﬂ ation has

remained low despite liberalizing energy prices and a large inﬂ ux of refugees.

ACTs have operated with limited exchange rate ﬂ exibility. Based on the IMF’s

de facto classiﬁ cation, ACT countries maintain pegged and intermediate

exchange rate arrangements. In particular, three of the six ACT counties—

Jordan, Libya and Morocco—maintain conventional pegs, while Egypt and

Tunisia use crawl-like arrangements and Yemen operates under a managed

ﬂ oat ( Table 3.1 ). Pegs in Jordan, Libya, and Morocco have been in place for

a long time, while Tunisia and Yemen have been making efforts to return to

more ﬂ exible arrangements. Egypt maintained a crawl-like arrangement since

2010 and has recently allowed at times for increased ﬂ exibility.

Some ACTs have been experiencing appreciation in their real effective

exchange rates (REERs). The evolution of the individual country

REERs reﬂ ects patterns in the anchor currencies (for countries

with pegs), movements of the price of oil, domestic price and wage

developments, and inﬂ ation differentials with trading partners. Compared

to their 2005 levels, the REERs of Yemen and Libya appreciated by about

Monetary and Exchange Rate Policy for Stability, Growth, and Jobs

Figure 3.4 . Inflation in Most ACTs Has Remained below the Emerging Market Average

(Consumer price inflation, 2013; year average, percent)

Yemen Egypt Tunisia Jordan Libya Morocco EMs

Sources: National authorities; and IMF staff calculations.

Table 3.1 . Structural and Exchange Rate Characteristics

Egypt Jordan Libya Morocco Tunisia Yemen

Resource-based

economies

No No Yes No No Yes

De facto exchange

rate policy

Crawl-like

arrangement

Conventional

peg

Conventional

peg

Conventional

peg

Crawl-like

arrangement

Other

managed float

Output gap 2013

(percent)

2.7 1.3

–

1.3 2.7 9.0

Current account

deficit, 2013

2.1 9.9 2.7 7.4 8.0 2.7

Exchange rate

assessment

2.6 to

14 percent

4.1 to

6.9 percent

0 to

15 percent

5 to

15 percent

0.9 to

6.7 percent

8.5 to

2.3 percent

Labor market

efficiency rank (1 =

best; 144 = worst)

142 101 137 122 . . . 138

Product market

efficiency rank (1 =

best; 144 = worst)

125 44 137 69 . . . 131

Food imports as

a share of total

merchandise

imports, 2010

19.2 15.9 . . . 11.9 8.9 34.0

Sources: IMF staff estimates; and World Economic Forum Global Competitiveness Index.

IMF Country Report 10/94.

IMF Country Report 12/119.

IMF Country Report No. 13/150.

IMF Country Report 13/69.

IMF Country Report 12/255.

TOWARD NEW HORIZONS

50 percent. In both cases, these increases were related to increased inﬂ ation

in the wake of higher oil-based spending, and subsequently to high inﬂ ation

in the context of Yemen’s economic crisis and stabilization (2011–13) and

Libya’s 2011 civil war. Egypt’s REER has been appreciating since 2007

because of high inﬂ ation, though that trend has recently halted, partly owing

to depreciation of the nominal exchange rate. Jordan experienced a milder

REER appreciation driven by the appreciation of the U.S. dollar since mid-

2010, and by inﬂ ation differentials with trading partners. In contrast, Morocco

and Tunisia’s REERs have been following a declining trend and are currently

below their 2005 levels ( Figure 3.5 ).

Figure 3.5 . Real Effective Exchange Rates Have Appreciated in Some ACTs

Sources: National authorities; and IMF staff calculations.

100

110

120

130

140

150

160

170

180

Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

Egypt

Jordan

Libya

Morocco

Tunisia

Yemen

Monetary and Exchange Rate Policies in Support

of High and Sustainable Growth

The choice of an exchange rate regime depends on the structure of the

economy. Important factors include the size of the economy, the degree of

openness and ﬁ nancial development, the diversiﬁ cation of the economy’s

production and exports, its exposure to shocks, concerns about domestic

inﬂ ation, the degree of labor and capital mobility, the extent of price

ﬂ exibility in product and labor markets, and the quality of institutions. In

addition, the degree to which existing regimes provide a well-functioning

inﬂ ation anchor and economic stability will be an important factor. Short-

term considerations may also include a need to maintain adequate levels of

international reserves and avoid any signiﬁ cant misalignment of the exchange

rate with fundamentals.

Monetary and Exchange Rate Policy for Stability, Growth, and Jobs

The empirical literature offers no consensus on the effect of exchange

rate regimes on macroeconomic performance.

Recent IMF empirical

work on the choice of exchange rate regime brings more balance to the

debate over which regime is appropriate, and suggests that there is no

“single prescription.” It also identiﬁ es important tradeoffs in the choice of

exchange rate regimes among the goals of economic performance (inﬂ ation

and growth), the vulnerability to real or nominal shocks, and the ease of

external adjustment.

Inﬂ ation and growth

Pegging the exchange rate provides a useful commitment device to anchor

inﬂ ation expectations. A well-established ﬁ nding in the literature is that pegs

are associated with lower inﬂ ation than more ﬂ exible arrangements because

they can anchor inﬂ ation expectations and provide macroeconomic stability.

Indeed, conventional pegs in Jordan, Morocco, and Libya have, on average,

yielded inﬂ ation rates 4 percentage points lower than in the other ACTs

since 2000.

International evidence associates faster growth with intermediate regimes.

Recent empirical evidence (Ghosh, Ostry, and Tsangarides, 2010) suggests

that intermediate exchange rate regimes are associated with the highest

average growth performance by capturing some of the beneﬁ ts of pegs

(low nominal and real exchange rate volatility, and trade integration)

while avoiding the main drawback (risk of exchange rate overvaluation).

Countries that allow for exchange rate ﬂ exibility also experience smaller

GDP losses in response to negative terms of trade shocks (Broda, 2004).

In the ACTs, average per capita growth performance since 2000 has been

similar across regimes.

Real and nominal shocks

The nature and magnitude of shocks facing the economy are important

considerations in choosing an exchange rate regime. Real external shocks

(such as terms of trade shocks) or nominal external shocks (such as

increases in trading partner inﬂ ation) are better accommodated with ﬂ exible

exchange rate regimes. In contrast, a ﬁ xed exchange rate regime may be more

See Ghosh, Gulde, and Wolf (2003), Levy-Yeyati and Sturzenegger (2003), and Reinhart and Rogoff (2004).

See Ghosh, Ostry, and Tsangarides (2010). Previous Fund work on exchange rate regimes includes Mussa and

others (2000) and Rogoff and others (2004).

See Ghosh Gude, and Wolf (2003), Rogoff and others (2004), and Klein and Shambaugh (2010).

TOWARD NEW HORIZONS

suitable when the economy faces domestic nominal shocks, such as those

originating from ﬂ uctuations in money demand.

The ACTs are subject to

signiﬁ cant real economic shocks including volatile terms of trade ( Figure 3.6 )

and their exposure to prices of imported goods, for example food prices, is

high. Some countries have also experienced money volatility, but this has not

necessarily translated into inﬂ ation volatility.

An important characteristic of more ﬂ exible exchange rates is that they

facilitate external adjustment. Recent empirical work using data from the past

three decades shows that ﬂ oating exchange rate regimes are associated with

smoother and faster external adjustment, while less ﬂ exible regimes are

associated with larger deﬁ cits, which can cease abruptly.

It appears that

this pattern broadly holds among the ACTs: Egypt, Tunisia, and Yemen—

countries with more ﬂ exible exchange rate arrangements—have, on average,

lower imbalances than those with pegs.

See Friedman (1953), Broda (2004), and Jbili and Kramarenko (2003).

See Ghosh, Ostry, and Tsangarides (2010), and Ghosh, Qureishi, and Tsangarides (2013).

Figure 3.6 . Real and Nominal Volatility, 2000–12

Sources: National authorities; and IMF staff calculations.

Calculated as the average three-year rolling coefficient of variation for

the corresponding period of time.

0.00

0.02

0.04

0.06

0.08

0.10

0.12

0.14

0.16

0.18

Libya Yemen Jordan Morocco Tunisia Egypt

Terms of trade index

Broad money/GDP

Monetary and Exchange Rate Policy for Stability, Growth, and Jobs

Structure of the economy

Undiversiﬁ ed resource-based economies beneﬁ t less from exchange

rate ﬂ exibility than non-resource economies do. As argued above, in an

environment where the scope for expenditure switching between traded

and non-traded goods is limited, exchange rate changes have only a small

effect on external positions and growth. By contrast, the undiversiﬁ ed export

structure implies that export earnings may be volatile and may ﬂ uctuate

with international commodity prices, which, under a ﬂ exible exchange rate

regime, would lead to large swings in the exchange rate. In the upswing

of the commodity price cycle, this would lead to signiﬁ cant exchange rate

appreciation hindering countries’ efforts at economic diversiﬁ cation, and

would suggest that commodity windfalls would be spent rather than invested

abroad for future generations.

Recommendations

Based on these criteria, each country will need to weigh the pros and cons

of pegging versus exchange rate ﬂ exibility on an individual basis. Inﬂ ation

will need to be kept contained, and inﬂ ation expectations well anchored. At

the same time, a key near-term challenge is to safeguard aggregate demand

in the face of weak growth and necessary ﬁ scal consolidation. In addition,

capital ﬂ ows must be restored so as to reverse the decline in reserves. This

outcome would come from a credible monetary and exchange rate policy

that reduces the impact of real shocks, supports measures to increase

competitiveness, controls inﬂ ation, and thus lays out a path for stable and job-

creating growth. For countries that opt for greater exchange rate ﬂ exibility,

this would require the establishment of a new anchor for monetary policy

and stepped-up technical capacity at the central bank, while pegging runs the

risk of a continued gradual buildup of vulnerabilities (including exchange rate

overvaluation and potentially increasing dollarization and balance sheet risks)

and implies the need to align ﬁ scal policy more closely with macroeconomic

objectives.

Countries that opt to allow more exchange rate ﬂ exibility may need to prepare

the ground. Central banks may need to build additional capacity, particularly

if they want to pursue inﬂ ation targeting (see below). Moreover, the presence

of adequate mechanisms for hedging foreign exchange risk for companies

and households would lessen the potentially negative impact of exchange rate

volatility, and sufﬁ ciently deep local capital markets could provide ﬁ rms with

an alternative to debt issuance in foreign exchange.

TOWARD NEW HORIZONS

Monetary policy under exchange rate ﬂ exibility

More ﬂ exibility in exchange rates brings with it the opportunity for more

proactive monetary policy but requires a strong monetary anchor. For

example, during times when demand is cyclically weak, job creation and

economic activity can be boosted through monetary policy easing. For this

approach to be effective, however, a strong monetary policy framework is

needed to anchor inﬂ ation expectations.

Under a set of preconditions, inﬂ ation-targeting regimes would be best

suited to addressing monetary policy challenges. Although there has been

a general trend towards adopting inﬂ ation-targeting regimes, including in

emerging markets, such regimes also require more developed monetary policy

institutions and instruments. Indeed, Egypt, Morocco, and Tunisia have

announced their intention to move toward inﬂ ation-targeting regimes once

the required institutional environment is complete. From the standpoint of

their varying degrees of progress, the ACTs would need to focus on four

main areas:

• Central bank capacity and independence. In some countries, central bank

independence should be strengthened through amendments in the legal

framework: requiring the appointment of independent Board members,

and specifying adequate rules for central bank lending to government

and ﬁ nancial institutions. In countries where the operational capacity of

the central bank is strong and independence is well established, there is

greater scope to move towards inﬂ ation targeting. This move will require

a solid understanding of the monetary policy transmission mechanism

and the ability of the central bank to pursue its inﬂ ation target

consistently. Inﬂ ation targeting cannot operate effectively in cases where

ﬁ scal dominance constrains monetary policy options.

• Political support. There is often a tradeoff between output and inﬂ ation

goals, which may undermine the extent to which the central bank can

credibly achieve inﬂ ation targets. Broader political support for central

bank independence and the inﬂ ation target is essential.

• Stable/low initial inﬂ ation. There are few situations where inﬂ ation targeting

has been successful when it was started in a high-inﬂ ation environment.

• Policy transparency and communication. Improvements in communication—

through regular monetary policy reports, public statements and, possibly,

publication of the minutes of policymaking meetings—can help provide

policy transparency and support public accountability, which underpins

operational independence.

Monetary and Exchange Rate Policy for Stability, Growth, and Jobs

During the transitional phase, countries could adopt a monetary aggregate

as a target. Given the institutional and policy requirements, ACTs are not

yet in a position to adopt full-ﬂ edged inﬂ ation-targeting regimes, though

some, like Morocco, are making signiﬁ cant progress in strengthening their

capacity. In the interim, countries could consider adopting a monetary

aggregate target (such as broad money) as the monetary anchor. Conventional

monetary targeting can be a useful disciplining tool for achieving monetary/

ﬁ scal restraint and managing inﬂ ation in the early stages of stabilization

under a ﬂ exible exchange rate. Countries that have or can gain higher policy

credibility, eliminate ﬁ scal dominance, deepen ﬁ nancial markets, and enhance

the analytical capabilities of central banks can transition towards more ﬂ exible

regimes that supplement monetary targeting with some forward-looking

aspects needed for inﬂ ation targeting—but without necessarily publishing an

explicit inﬂ ation target in the initial stages.

For countries that opt for increased exchange rate ﬂ exibility, policymakers

can address stakeholders’ resistance by empowering beneﬁ ciaries and

compensating losers. In addition to concerns about adverse macroeconomic

consequences, obstacles to increased exchange rate ﬂ exibility may arise

from interest groups that have divergent views on the exchange rate regime,

level, and distributional effects, and from the governments’ institutional and

political strength to identify and tackle vocal interest groups. For example,

if food and energy are a large component of imports and the consumption

basket, consumers may be resistant to increased ﬂ exibility because of the

uncertainty this would imply for their purchasing power. Addressing these

and other concerns requires a concerted effort by the authorities to empower

beneﬁ ciaries of reform, build coalitions, consider ways to compensate groups

that stand to lose, and sequence reforms with realistic timing ( Chapter 6 ).

CHAPTER

Bolstering Financial Stability

and Development

Financial systems in the ACTs could gain signiﬁ cantly from reforms that

foster ﬁ nancial stability and development. Although banks are sizeable,

competition remains limited, with signiﬁ cant state ownership in many cases,

and credit is highly concentrated in a few large, well-connected borrowers.

The nonbank ﬁ nancial sector remains underdeveloped. In consequence,

access to ﬁ nance for most people and ﬁ rms remains very limited, highlighting

the large potential gains from fostering inclusive ﬁ nancial development. At the

same time, elevated levels of nonperforming loans (NPLs) in many banking

systems point to a needed focus on policy areas that help reinforce ﬁ nancial

stability.

Figure 4.1 . Bank Credit is Large in Most ACTs

(Bank private credit to GDP, 2007–11 average; percent)

Source: World Bank Global Financial Development database.

ACTs

EGY

JOR

LBY

MAR

TUN

YEM

MENA

World

East Asia and Paciﬁc

Lan America & Caribbean

Europe & Central Asia

South Asia

Sub-Saharan Africa

Bolstering Financial Stability and Development

Banking systems are relatively large compared to other regions, with credit

concentrated in large, established companies. The ACTs compare well

with other countries in the world in the size of ﬁ nancial intermediation, as

measured by credit to the private sector over GDP, except for Libya and

Yemen ( Figure 4.1 ). The average ratio of private sector credit to GDP is

higher than in other regions, and bank credit overshadows other sources of

ﬁ nance. This ﬁ nding is not surprising, given the large deposit bases and loan-

to-deposit ratios in general in the MENA region. However, credit remains

very concentrated in many countries, and its beneﬁ ts disproportionately go to

large companies (Barajas and others, 2013.)

Lack of access to ﬁ nance is a major constraint for ﬁ rms and households.

Only 7 percent of ﬁ rms use banks to ﬁ nance investment, by far the lowest

share among the world’s regions ( Figure 4.2 ); and more than 30 percent of

ﬁ rms identify access to ﬁ nance as a major constraint, a higher percentage

than in all other regions except sub-Saharan Africa ( Figure 4.3 ). In some

ACTs only a small share of adults have bank accounts ( Figure 4.4 ); this low

access to ﬁ nance has been the result of a variety of factors, including poor

ﬁ nancial infrastructure, weak banking competition, connected lending, and

underdevelopment of the nonbank ﬁ nancial sector.

Many ACT banking systems suffer from elevated NPLs. Poor risk

management in banks, combined with weak ﬁ nancial infrastructures, have

resulted in a higher ratio of NPLs compared to other regions; in some

countries it is also the result of a history of connected lending between

Figure 4.2 . Few Firms Use Bank Credit to Finance Investments

(Percent of firms using banks to finance investments, latest year available)

Source: World Bank Enterprise Surveys.

EGY

JOR

MAR

YEM

MENA

World

East Asia & Paciﬁc

Lan America & Caribbean

South Asia

Sub-Saharan Africa

Eastern Europe

ACTs

TOWARD NEW HORIZONS

Figure 4.3 . Relatively Few People in the ACTs Maintain Bank Accounts

(Adults with an account at a formal financial institution to total adults, 2011; percent)

Source: The World Bank Global Financial Development database.

EGY

JOR

MAR

TUN

YEM

MENA

World

East Asia and Paciﬁc

Europe & Central Asia

Lan America & Caribbean

South Asia

Sub-Saharan Africa

ACTs

Figure 4.4 . Access to Finance is a Major Constraint

(Percent of firms identifying access to finance as a major constraint, latest year available)

Source: World Bank Enterprise Surveys.

EGY

JOR

MAR

YEM

MENA

World

East Asia & Paciﬁc

Lan America & Caribbean

South Asia

Sub-Saharan Africa

Eastern Europe

ACTs

state-owned banks and state-owned enterprises, and of the economic

downturn in the context of political transitions ( Figure 4.5 ).

T h e ﬁ nancial infrastructure in the ACTs is weak. The ACTs still depend on

traditional public credit registries, and even the countries that have introduced

private credit bureaus are lagging behind other regions in coverage and

Bolstering Financial Stability and Development

Figure 4.5 . Nonperforming Loans are High

(Nonperforming loans, 2013 or latest month or year available; percent)

Sources: IMF Financial Soundness Indicators database; World Bank Global

Financial Development database; and MCD high-frequency database.

Egypt

Jordan

Libya

Morocco

Tunisia

Yemen

MENA

World

East Asia and Paciﬁc

Europe & Central Asia

Lan America & Caribbean

South Asia

Sub-Saharan Africa

ACTs

Figure 4.6 . ACTs Rank Last in Legal Rights

(Strength of legal rights, latest year available; 0–10)

Source: World Bank, Doing Business.

EGY

JOR

MAR

TUN

YEM

MENA

East Asia & Paciﬁc

Eastern Europe

Lan America & Caribbean

OECD high income

South Asia

Sub-Saharan Africa

ACTs

quality of information (Madeddu, 2010). In addition, the ACTs have severe

weaknesses in almost all components of collateral regimes: the region ranks

last in the area of credit rights as measured by the legal rights index of the

World Bank’s Doing Business indicators ( Figure 4.6 ). Insolvency regimes

suffer from the lack of efﬁ cient exit mechanisms and protection for secured

creditors (Rocha and others, 2011b).

TOWARD NEW HORIZONS

Bank competition is lower than in most emerging market regions (Anzoategui,

Martinez Peria, and Rocha, 2010). The ACTs have the largest bank

concentration in the world (as measured by the share in total assets of the

three largest banks in each country), stiﬂ ing competition ( Figure 4.7 ). Weak

Figure 4.7 . Bank Concentration is High

(Three largest banks, 2007–11, average; percent)

Sources: World Bank Global Financial Development database.

100

EGY

JOR

LBY

MAR

TUN

YEM

MENA

World

East Asia and Paciﬁc

Europe & Central Asia

Lan America & Caribbean

South Asia

Sub-Saharan Africa

ACTs

Figure 4.8 . Government Debt Markets Remain Underdeveloped

(Outstanding public debt securities to GDP, 2007–11 average; percent)

Sources: National authorities; and World Bank Global Financial Development

database.

¹Average for 2008–11.

EGY

JOR

MAR¹

TUN¹

YEM

MENA

World

East Asia and Paciﬁc

Europe & Central Asia

Lan America & Caribbean

South Asia

Sub-Saharan Africa

ACTs

Bolstering Financial Stability and Development

competition is also explained by a weak credit culture, complicated licensing

requirements, and the dominant role of state-owned banks.

Nonbank ﬁ nancial sectors remain underdeveloped in most ACTs. The

ﬁ nancial landscape is dominated by the banking sector. The nonbank ﬁ nancial

sector consists mainly of government bond markets and equities, with little

presence of private ﬁ xed-income market or corporate issuers. The stock of

traded public bonds is sizable and constitutes an important instrument for

domestic portfolios ( Figure 4.8 ); however, government debt markets remain

underdeveloped, with scope for further deepening and improving market

liquidity and broadening the investor base. The stock of private ﬁ xed-income

instruments is negligible; there is very little issuance of corporate bonds,

mortgage-backed securities, or other asset-backed securities. Thus there are

few alternatives to bank ﬁ nancing for corporations and small and medium-

sized enterprises (SMEs).

Stock markets in some ACTs are large but have limited trading volume.

The average stock market size is large, as measured by the ratio of market

capitalization to GDP ( Figure 4.9 ). However, the amount of stocks

available for portfolio investment is small in many countries, as indicated

by the low free ﬂ oat compared to international average, and reﬂ ects the

large number of family-controlled companies and concentrated ownership

structures in the region.

Capital markets are not supported by a solid domestic private institutional

investor base. The lack of private institutional investors (insurance companies,

Figure 4.9 . Stock Markets are Large in Some ACTs

(Stock market capitalization to GDP, 2007–11, average; percent)

Sources: World Bank Global Financial Development database.

100

120

140

160

EGY

JOR

MAR

TUN

MENA

World

East Asia and Paciﬁc

Europe & Central Asia

Lan America & Caribbean

South Asia

Sub-Saharan Africa

ACTs

TOWARD NEW HORIZONS

mutual funds, and private pension funds) operating in capital markets is

one of the main hindrances to promoting the role of the capital market

in supporting growth ( Figure 4.10 ) and, combined with a large number

of uninformed small individual investors, a few high net worth individual

investors, and large state investors, raises questions about the quality of price

discovery (Rocha and others, 2011a).

In light of these trends and structural impediments, the ACTs need a bold

agenda for ﬁ nancial access and stability. Starting points and reform needs

vary across countries, but there are a number of common areas for reform.

There is a clear need to expand access to ﬁ nance, particularly for SMEs, to

enable entrepreneurial acivity and spur job-creating growth. Countries also need

to develop alternatives to bank ﬁ nance, including private bond issuance. This

will further their economic development and, in countries where bank ﬁ nancing

for the public sector limits the availability of private sector credit (see Chapter 2 ),

can help address a key bottleneck. Fostering Islamic ﬁ nance will contribute

to the inclusion of wider segments of the population in the ﬁ nancial system,

and thus help to build a more inclusive economic model. Finally, continued

improvements to ﬁ nancial stability are needed to ensure stable economic

conditions for growth and job creation. The wide range of potential reform

areas suggests a need for careful prioritization and sequencing, and for a ﬂ exible

approach so that reform opportunities can be seized as they arise.

The rewards of successful reform can be signiﬁ cant. Empirical estimates

show that raising access to ﬁ nance to the world average could increase per

Figure 4.10 . Private Institutional Investors are Lacking in Some Countries

(Insurance company assets to GDP, 2007–2011 average; percent)

Source: World Bank Global Financial Development Database.

EGY

JOR

MAR

TUN

MENA

High Income

East Asia and Paciﬁc

Europe & Central Asia

Lan America & Caribbean

South Asia

Sub-Saharan Africa

ACTs

Bolstering Financial Stability and Development

capita GDP growth by over 0.1 percent per annum on average for the MENA

region, and by substantially more in countries with high access constraints

(Bhattacharya and Wolde, 2010). Moreover, ﬁ nancial development and

stability can signiﬁ cantly reduce income inequality and poverty, and potential

gains in these areas are much larger in the ACTs than in other regions in the

world (Ben Naceur and Zhang, forthcoming).

Expanding Access to Finance Through the Banking System

Strategies to enhance access to ﬁ nance need to address shortcomings in

the banking system, which is expected to continue dominating the ﬁ nancial

landscape in the coming years. The ﬁ nancial infrastructure in the ACTs is much

weaker than in other regions, and bank competition is low. Addressing these

two priority areas could substantially improve access to ﬁ nance and lending

for SMEs, strengthening equality of economic opportunity, and supporting

job-creating growth.

Strengthening the ﬁ nancial infrastructure should include improving credit

information systems, enhancing collateral regimes, and reforming insolvency

regimes. There have already been improvements in credit information with

the introduction of private credit bureaus ( PCBs) in Egypt and Morocco, the

enacting of a customized credit reporting law in Jordan (in preparation for

creation of a PCB in 2014), and the upgrade of the public credit registry ( PCR)

in Tunisia. Nevertheless, more needs to be done to improve the coverage and

depth of credit information, especially for SMEs: data contribution in credit

reporting should be mandatory and should include all loans; positive and

negative data should be available; utilities and telecommunications providers

should be included; inquiry to the PCR or PCB should be mandatory before

granting credit; a National Identiﬁ cation Number (NID) system should to be

created for credit reporting purposes; and PCBs should be given incentives to

develop value-added services (such as credit scores and ratings of SMEs) (see

Maddedu, 2010).

Collateral regimes should be strengthened to improve creditor protection. The

legal and regulatory frameworks for secured transactions need to be improved

by allowing broad pools of assets to be accepted as collateral (e.g., receivables

and inventories), by simplifying the procedure for creating security interests

on movable assets, by developing modern electronic collateral registries, and

by strengthening enforcement mechanisms including the introduction of

effective out-of-court enforcement mechanisms (Alvarez de la Campa, 2011).

While considerable progress has been made on the legal front, insolvency

regimes in the ACTs remain underdeveloped. Only a few countries (such

as Morocco) have introduced an insolvency regime that gives priority to

corporate restructuring (Tahari and others, 2007). Considerable room

TOWARD NEW HORIZONS

remains for modernizing bankruptcy and foreclosure proceedings.

More speciﬁ cally, bankruptcy should be decriminalized, liquidation

and reorganization procedures should be made more efﬁ cient through

improved court functioning, and bankruptcy professionals need to be

better trained in the economics of distressed ﬁ rms and commercial matters

(Uttamchandani, 2011).

Strengthening competition among banks will also be important, to create

better incentives for them to expand their lending. Strict entry requirements, a

weak credit information system, and lack of competition from capital markets

and the nonbank ﬁ nancial system are among the main impediments to stronger

bank competition in the ACTs (Anzoategui and others, 2010). Enhancing

competition in the banking sector may require the review of licensing

requirements to ease bank entry (though without undermining the quality of

entrants), the removal of remaining barriers to entry for reputable foreign

ﬁ nancial institutions (for example, greenﬁ eld bank licenses have generally not

been granted (see the World Bank/IMF Tunisia Financial Sector Assessment

Program, 2012)); the development of nonbanking ﬁ nance institutions and

capital markets (see below); the elimination of any preferential treatment in

the regulatory, supervisory, and tax treatment of public and private banks; the

reduction of loan concentration and connected lending through enhanced

prudential measures and additional capital requirements; a continuous effort to

promote ﬁ nancial instrument transparency; and the creation of a competition

agency with the mandate of ensuring competition in the ﬁ nancial sector.

The steady growth in Islamic banking during the past decade suggests

that it has started to move into the mainstream of the banking system.

The participatory nature of the Islamic banking business model helped to

minimize the adverse impact of the global ﬁ nancial crisis on Islamic banks

(Hasan and Dridi, 2010). The prospects for Islamic banking are favorable,

with further growth expected, and Islamic banks are evolving rapidly in the

variety, distribution, and operational complexity of their products, to meet

the challenges of Shari’a compliance and competition. Some jurisdictions

have amended their regulatory systems to incorporate Islamic banking–related

legislation, to increase consumer conﬁ dence, and to create an environment

conducive to expansion and economic growth. Weaknesses persist in the

risk management framework for Islamic ﬁ nancial institutions, however, and

their risk management capacities are in need of comprehensive overhaul

(Hasan and Dridi, 2010). Policymakers are advised to adopt Islamic banking

guidelines issued by industry associations, such as the Islamic Financial

Services Board (IFSB), International Islamic Financial Market, and the Basel

Committee on Banking Supervision, on quality and regulatory capitalization,

risk oversight, leverage ratios, and macro prudential buffers (IFSB, 2013).

Adopting new technologies, improving ﬁ nancial literacy, and ensuring

consumer protection will also boost ﬁ nancial inclusion. Introducing new

Bolstering Financial Stability and Development

technologies in the ﬁ nancial sector, such as mobile payment, mobile banking,

electronic credit information systems, and biometric identiﬁ cation systems,

can help lower the barriers to accessing ﬁ nancial services. Improving ﬁ nancial

literacy for the young and for those with lower levels of ﬁ nancial education

can have measurable effects (Miller and others, 2013). Consumers will also

need to be protected, through more transparency and disclosure by lenders,

and through effective recourse mechanisms.

Beyond Banks: Diversifying the Financial System

Diversifying the ﬁ nancial sector should focus on creating alternative sources

of ﬁ nancing, particularly for SMEs, and improving the functioning and

liquidity of local capital markets. Towards that end, ACTs should develop

medium-term strategies for (i) deepening local bond markets and catalyzing

private issuance; (ii) expanding the institutional investor base, including the

pension and insurance industries; (iii) developing alternative instruments to

bank ﬁ nancing, such as leasing and factoring, and promoting microﬁ nance;

(iv) fostering the development of Sukuk (Islamic ﬁ xed-income securities)

markets to meet the growing demand for new asset classes for diversiﬁ cation

purposes, with rigorous regulatory and supervisory frameworks in place. Over

the longer term, improving corporate governance and investor education will

contribute to attracting corporate issuers to the local bond and equity markets.

Deepening local bond markets and catalyzing private issuance

There is large potential for developing private bond issuance as an alternative

to bank ﬁ nancing. Private ﬁ xed-income markets are largely underdeveloped

within the ACTs, limiting the options of ﬁ nancing and investment channels

(Rocha and others, 2011a). Corporate bond issuances within ACTs remain

small and, for the most part, limited to banks in countries like Morocco

and Tunisia, where they are used mainly to build up Tier 2 capital or for

compliance with regulations limiting maturity mismatches. Fixed-income

funds are very small, amounting to approximately US$15 billion, or

25 percent of total assets under management (Morocco and Tunisia). Private

ﬁ xed-income instruments such as corporate bonds, corporate Sukuk, asset-

backed securities, mortgage-backed bonds, and covered-mortgage bonds can

be essential pillars, providing long-term ﬁ nancing to the private sector and

diversifying the ﬁ nancial sector.

Strategies to catalyze bond issuance should take a dual approach, pursuing both

domestic and regional market development initiatives. The limited pool of

savings and the underdeveloped institutional investor class (see above) pose

structural constraints for the market’s potential scale, liquidity, and efﬁ ciency.

Because it takes time for institutional investors to develop, the strategy for

TOWARD NEW HORIZONS

boosting private domestic bond issuance could be expanded or adapted to

include a regional dimension.

Near-term policies to strengthen domestic issuance of ﬁ xed-income

instruments should focus on creating an enabling environment.

A sustainable macroeconomic environment, and stronger conﬁ dence in

the ACT economies, as discussed in previous chapters, will be necessary

preconditions. In addition, policymakers should identify priority areas for

encouraging corporate bond issuance, including (i) creating a benchmark

yield curve for government securities so as to improve pricing of corporate

bonds; (ii) increasing market efﬁ ciency by setting up solid corporate

governance structures, including adopting global sound transparency and

disclosure practices to monitor risk; (iii) improving market infrastructure by

aligning primary market structures (for example, issuing process and listing

conditions) with the needs for efﬁ cient secondary market operations (volume,

regular issuance, allocation) and building efﬁ cient electronic platforms for

smoother market functions such as clearing and settlement; (iv) fostering a

skilled human resources and knowledge base for regulatory, supervisory, and

operational purposes by providing the necessary educational and technical

training; and (v) developing capacity-building programs for corporate issuers,

to strengthen the professional and competitive environment (Rocha and others,

2011a). Improving the supervision of large bank exposures and connected

lending, as well as adding capital requirements for banks with high credit

concentration, can help encourage large ﬁ rms to issue bonds.

The ACTs should focus on putting in place the foundations for an active

government bond market as a catalyst for private issuance. Some countries

(Egypt, Jordan, Morocco) with large outstanding government securities

and regular issuance can build on good initial conditions. Further action

is required to improve market structure and secondary market liquidity,

including monetary policy implementation and liquidity management to

improve money market functioning; enhancements to the debt management

strategy and issuance practices; and measures to diversify the investor base,

including foreign participation. Key market shortcomings are found in the

maturity structure, auction calendars, concentration of demand, and lack

of liability management techniques. The maturity structure is generally

unbalanced and does not always cover key points on the yield curve. With

the exception of Egypt, countries do not comply with a predictable auction

calendar, resulting in irregular supply of instruments. The authorities in

other ACTs should prioritize building a reliable benchmark yield curve with a

regular issuance calendar.

A large and diversiﬁ ed investor base is important for ensuring high liquidity

and stable demand in the ﬁ xed-income market. A heterogeneous investor

base, with different time horizons, risk preferences, and trading motives,

Bolstering Financial Stability and Development

ensures active trading and stimulates liquidity, enabling the government

to execute its funding strategy under a wide range of market conditions.

Similarly, a diversiﬁ ed investor base will provide demand for privately issued

ﬁ nancial instruments such as bonds and equities. Egypt and Jordan have

the least diversiﬁ ed investor bases, with banks and state-owned entities

holding more than 75 percent of issued debt (Rocha and others, 2011a).

Secondary markets are generally shallow, as a result of excess liquidity and

an undiversiﬁ ed investor base. Efforts to encourage the development of

insurance, pension, and mutual funds industries over the medium term are

necessary to diversify and improve the resilience of the ﬁ nancial sector and to

make the best use of the signiﬁ cant amount of national saving in the region

( Figure 4.11 ). State insurance companies and pension funds dominate the

industries and limit competition and innovation.

Developing the insurance sector so it can play a role as institutional investor

can help to broaden the investor base. Egypt has made progress towards

allowing the entry of private companies and restructuring state insurers.

Upgrading the regulatory framework for insurance sectors is a priority,

because insurance supervisors lack adequate legal, administrative, or

budgetary independence. Financial Sector Assessment Programs have

identiﬁ ed several common weaknesses in supervisory practices, including

weak ﬁ nancial reporting; weak corporate governance; problems with illegal

and excessive payments to agents and brokers; lack of consumer protection

mechanisms; and limited information available to the public (Egypt, Jordan,

and Morocco are notable exceptions).

Promoting the development of private pension funds will also help

strengthen the domestic investor base. Some countries have recently taken

Figure 4.11 . Potential for Developing the Investor Base

(National savings rate, 2013; percent of GDP)

Sources: National authorities; and IMF staff calculations.

Morocco Libya Jordan Tunisia Egypt Yemen

EM average

TOWARD NEW HORIZONS

steps toward this goal, including Egypt and Jordan; however, pension schemes

remain small and under-regulated. By contrast, public pension funds have

accumulated large reserves as a result of the young demographic proﬁ le

of their populations. Accumulated reserves exceed 20 percent of GDP

in Egypt, Jordan, and Morocco. In many cases, asset management is not

outsourced to independent investment managers, and assets are largely held

in nontradable government bonds, resulting in their effective assimilation

into unfunded pension schemes (Egypt). In other countries, public pension

funds adopt conservative investment policies that include large holdings of

government securities and bank deposits, and restrict holdings of foreign

assets. In Jordan and Morocco, public pension funds seem to be adopting

more modern asset allocation strategies and have expanded their allocations to

equities, though investments in foreign assets are subject to low limits.

Over the medium term, a number of additional policy steps can be taken

toward development of an active ﬁ xed-income market. These include:

•

Strengthening investor protection

(e.g., ﬁ nancial and nonﬁ nancial

institutions, pension funds, and mutual funds etc.) by building the

necessary comprehensive legal, regulatory, and supervisory framework, in

addition to developing a ﬂ exible collateral system, is critical to mobilizing

resources and ensuring the development of a broader and deeper private

bond market (only Morocco and Tunisia have securitization laws).

•

Promoting investor awareness

by launching public awareness

campaigns to encourage investors to diversify their investment portfolios.

•

Building a strong asset management industry

to offer retail investors

the opportunity to penetrate the bond market at low cost.

•

Developing new investment products

such as mortgage-backed

securities, along with parallel development of derivative markets for risk

management purposes.

•

Gradually liberalizing capital account restrictions

to enable foreign

investors to enter and diversify the investor base and improve liquidity.

Exploring the potential for a regional bond market initiative could overcome

constraints to bond market growth in individual countries. Individual markets

are small, and a regional initiative could have the advantage of presenting

foreign investors with a uniﬁ ed set of rules, lowering their cost for market

entry. To support such an initiative, governments should consider

introducing standardized market rules and regulations and tax codes across the

See: Rocha and others, 2011a .

Bolstering Financial Stability and Development

region; creating regional credit guarantee schemes; and allowing for regional

credit rating services and clearing and settlement associations (Parreñas and

Waller, 2006). Governments should also continue to relax the remaining

capital controls to support the regional capital market initiative. These steps

should be pursued in partnership with the private sector and in collaboration

with regional bodies and oil-exporting countries’ funds.

Strengthening alternative ﬁ nancing instruments

Developing the leasing industry can help overcome some obstacles that hold

back bank lending and help SMEs gain access to ﬁ nance. Leasing offers some

potential advantages over bank lending: leasing companies retain ownership

of the leased asset, overcoming some of the effects of weak creditor rights

that hinder commercial bank lending to SMEs; and leasing companies are

often established as joint ventures between equipment manufacturers and

ﬁ nancial institutions, and beneﬁ t from the technical support of their founders.

Leasing should be particularly attractive for SMEs in ACTs, because these ﬁ rms

do not have long credit histories or signiﬁ cant collateral. In addition, as an asset-

based ﬁ nancing operation, leasing is inherently a Shari’a-compliant product.

Despite these potential advantages, the leasing industry is very small in the

region. In Tunisia, it accounts for about 10 percent of gross capital formation,

followed by Jordan and Morocco at less than 5 percent. That said, markets are

growing quickly in the ACTs, revealing strong demand for the product and

potential for further growth. The dominant types of leasers are banks and

bank-related institutions, because of their easier access to funding. Policies to

promote leasing should focus on strengthening the legal framework, including

the enforcement of contractual and proprietary rights, and improving the tax

framework to establish clear and neutral tax treatment.

Supporting venture capital and private equity can help innovation. Private

equity investment in MENA is very low at 0.05 percent of GDP (2012), well

below world averages (MENA Private Equity Association, 2013). To support

development of private equity and venture capital, ACT governments can

consider guarantee schemes for venture capital investment in startups; foster

collaboration between incubators, research and venture capital companies;

streamline the legal and tax systems to remove complications; reinforce the

protection of property rights; allow foreign investment in the industry; and

consider the creation of special public funds to alleviate the lack of funding in

the industry (OECD, 2006).

Bolstering microﬁ nance

Strengthening microﬁ nance could spur inclusive growth by providing

economic opportunity for the smallest businesses and the poor. Microﬁ nance

is still limited in scale, reaching only 1.8 percent of the adult population

TOWARD NEW HORIZONS

in the ACTs, about half the proportion in South Asia or Latin America.

It continues to be constrained by the absence of a clear regulatory and

supervisory framework, inadequate institutional models, and poor ﬁ nancial

infrastructure (Pearce, 2011). Most microﬁ nance institutions (MFIs) in the

ACTs are non-deposit-taking NGOs. In some countries, including Tunisia,

banks are restricted by interest caps that make microloans unproﬁ table.

In most countries, MFIs are not included in the formal credit information

system. Reforms to promote microﬁ nance should focus on developing a

ﬁ nance company model for microﬁ nance (allowing microcredit NGOs to

evolve into ﬁ nance companies), increasing ﬂ exibility for interest rate setting

for microcredit, moving microﬁ nance under the umbrella of the ﬁ nancial

regulator, strengthening consumer protections, and integrating microﬁ nance

borrower information into credit bureaus (Rocha and others, 2011a).

Islamic Finance for Financial Deepening and Access

Some ACTs have signaled interest in developing Islamic ﬁ nance.

These

countries face increased investor demand and rapid growth of Shari’a-

compliant products ( Figure 4.12 ). Developing ﬁ nancial products along

Islamic principles encourages ﬁ nancial intermediation for groups of

society that would otherwise not participate in the formal ﬁ nancial system,

thereby fostering access to ﬁ nance and an inclusive economic model. ACTs

have recently amended their existing ﬁ nancial legal and regulatory systems

to incorporate a suitable legislative environment for Islamic ﬁ nance,

including Sukuk capital markets. Libya is taking a different approach by

requiring the complete conversion to a full-ﬂ edged Islamic ﬁ nance system

by 2015.

Integrating Islamic ﬁ nance instruments into the existing ﬁ nancial system

remains a challenge. Developing additional dynamic investment products

requires concerted efforts over a period of time to create sufﬁ cient depth

and liquidity for the new instruments, and to educate investors about

the associated risks. Most Islamic ﬁ nance contracts like Sukuk securities

share some operational similarities to these of conventional bonds. Such

resemblance is embedded in the characteristics of issuance, coupon payments,

redemption procedures, and default clauses. It is important to guard against

market fragmentation with too many instruments, given the thin instrument

liquidity and narrow investor base in most ACTs. The Islamic ﬁ nance

industry is becoming a mainstream asset class: its regulatory and supervisory

Based on Shari’a laws, in Islamic finance, transactions are based on the principle of profit and loss sharing;

interest payment ( Riba ) and trading in financial risk products ( Gharar ) such as derivative products are prohibited.

Bolstering Financial Stability and Development

frameworks in areas such as regulation, accounting, governance, and

infrastructure are still being developed, including ensuring that the investment

products are actually Shari’a-compliant and only mimic conventional products

to target ﬁ nancial institutional investors.

A number of policies can help provide investors with a stable asset class. Over

time, it is advisable to develop a comprehensive regulatory and supervisory

framework for Islamic ﬁ nance products, to support sound market growth and

guard against risks to ﬁ nancial stability. Improving the transparency of the

underlying asset structure and clarifying the legal framework and investors’

rights would facilitate accurate valuation, pricing, and credit rating mechanisms

in case of liquidation or restructuring. In addition, policymakers should focus

on boosting supervisory capacity and introducing supporting policies such

as: (i) standardizing products and unifying specialized Shari’a committee

rulings on the compliance of Islamic ﬁ nance contracts with Shari’a law, to

minimize legal uncertainty among investors; (ii) considering how Shari’a-

compliant products would be integrated into the existing ﬁ nancial system and

operations of ﬁ nancial institutions; (iii) reviewing existing tax codes to ensure

equal treatment of Islamic ﬁ nance products and conventional ﬁ nance; (iv)

integrating Islamic ﬁ nance into dealership systems and electronic clearing for

speedy and cost-efﬁ cient operation, to reduce cost and risk; (v) developing a

robust and efﬁ cient liquidity management framework to help Islamic ﬁ nancial

institutions in performing funding and investment activities; and (vi) cultivating

skilled human resources and the knowledge base, as Islamic ﬁ nance involves a

mixture of specialized qualiﬁ cation in legal, Shari’a, and ﬁ nancial expertise.

Safeguarding the Stability of the Financial System

Reinforcing systems to safeguard ﬁ nancial stability is a high priority.

Promoting ﬁ nancial development and access to ﬁ nance will strengthen growth

Figure 4.12 . Global Assets of Islamic Finance Have Grown

(Billions of U.S. dollars)

Source: The Banker , Ernst & Young, 2013.

509

677

861

933

1130

1289

500

1000

1500

2006 07 08 09 10 11

TOWARD NEW HORIZONS

potential and promote equal economic opportunity, but the economic woes

that have followed in the wake of the Arab Spring have highlighted the need

to remain vigilant and support ﬁ nancial stability. There are four main areas

in which the ACTs can enact improvements: macroprudential regulation

and supervision, ﬁ nancial safety nets and crisis management systems,

microprudential regulation and supervision, and bank governance rules.

Macroprudential regulation and supervision

Macroprudential policy must deploy a range of tools to address aggregate

weakness and mitigate systemic risk. The authorities should tailor speciﬁ c

macroprudential instruments to their particular vulnerabilities. Some tools

can address the buildup of aggregate risks over time: these include dynamic

capital buffers that require banks to set aside money to cover loan losses in

good times; varying sectoral risk weights to cover new loans in sectors that are

building up excessive risks; loan-to-value ratios to reduce systemic risk from

boom-bust episodes in real estate markets; and measures to limit exposure to

foreign currency lending.

Effective macroprudential policies require adequate institutional underpinnings.

These need to take into account country-speciﬁ c circumstances and differences

in institutional capacity. The arrangements should foster effective identiﬁ cation

of developing risks; provide strong incentives to take timely and effective

action to counter those risks; and facilitate coordination across policies that

affect systemic risk (Nier and others, 2011). To achieve these goals, complex

and excessively fragmented structures should be avoided.

Financial safety nets and crisis management

Reﬁ ning the current model of ﬁ nancial safety nets and crisis management

would help reduce moral hazard. By effectively not allowing banks to fail,

the current approach has guaranteed the stability of the ﬁ nancial system, but

it has reduced the incentives for private monitoring of the health of ﬁ nancial

institutions. The framework would therefore beneﬁ t from a number of

enhancements to strengthen market discipline.

Modernizing deposit insurance will be an important element. A well-designed,

explicit limited-coverage deposit insurance system (DIS) can promote market

discipline and protect small depositors from losses. There are four DISs in the

ACTs: a pure pay-box system

under central bank management in Morocco

A pure pay-box system has three basic roles: premium collection, fund management, and depositor

reimbursement. This system assumes no significant role in bank resolution and the disposition of failed insured

institutions (IADI, 2007).

Bolstering Financial Stability and Development

and Libya, and operationally independent systems in Jordan and Yemen.

Although the essential design of the explicit DISs in the ACTs is largely in line

with the International Association of Deposit Insurers (IADI) core principles,

there are some divergences that need to be addressed. Tunisia and Egypt need

to transition from blanket government guarantees to a properly designed

explicit limited-coverage DIS, preferably at a time when the macroeconomic

environment is stable and the banking sector is sound. The reform of existing

DISs should mainly focus on transforming the pure pay-box system into

an effective tool for resolution, reinforcing the legal protection of those

working in DISs, providing backup funding for the DIS (for example, a

credit line with the government), adequately covering the large majority of

small depositors, and moving from a ﬂ at-rate premium system to a risk-

based one.

The introduction of special resolution regimes could be useful for the

prompt and orderly resolution of failed banks. These regimes should allow

banking authorities to take control of a bank at an early stage of its ﬁ nancial

difﬁ culties, to use a wide array of instruments to deal with a failing bank

without the consent of shareholders (e.g., acquisition by a sound ﬁ nancial

institution; creation of a bridge bank; partial transfer of deposits and assets to

a “good bank”); specifying a regulatory threshold for initiating the resolution

process; and establishing ﬁ nancial stability as its main objective (Cihak

and Nier, 2009). Steps also need to be taken to introduce an effective crisis

management framework in which a memorandum of understanding should

deﬁ ne the respective roles of the Ministry of Finance and the supervisory

authorities during a systemic crisis. Conducting periodic simulation exercises

would help prepare all stakeholders to intervene coherently during an

unexpected crisis. It can be also helpful to put in place a coordinating

committee that will be in charge of crisis preparedness activities during

normal times and in charge of crisis management during a crisis.

Modalities for emergency liquidity assistance should be strengthened

and separated from monetary operations. The central bank should stand

ready to promptly provide funds to solvent but illiquid banks secured by

acceptable collateral. A haircut system should be introduced for loans to

be used as collateral in the central bank reﬁ nancing operation. Emergency

liquidity assistance should be more expensive than other instruments, to

encourage banks to ﬁ rst look for funding from other sources (IMF Staff

Report for the 2013 Article IV Consultation with Tunisia).

Microprudential regulation and supervision

Implementing effective risk-based supervision and enhancing the capacity

and resources of supervisors remain a priority and a challenge. Capital

requirements should better reﬂ ect individual institutions’ risk proﬁ les as

TOWARD NEW HORIZONS

well as macroeconomic risks. This requires progress towards risk-based

supervision to deﬁ ne additional capital requirements. Supervisors should work

towards adopting relevant Basel standards in a timely manner, and consider

introducing a capital conservation buffer in line with Basel III.

Several countries, among them Egypt, Jordan, and Morocco, have made

progress in bringing supervision into line with international standards.

Risk-based supervision requires a transition from focusing on regulatory

compliance to understanding and assessing banking groups’ risk proﬁ les

and strategies, and taking appropriate supervisory actions in response. This

transition generally calls for new supervisory methodologies, allowing for risk

prioritization of on-site inspections and structured off-site risk analyses; a

better understanding of the environment in which banks operate; adequate

resources and staff able to understand, identify, and quantify risk; and

effective coordination between offsite and onsite supervision.

Policies should aim at reducing credit concentration. Credit concentration

is a shared characteristic that to some extent reﬂ ects economic structures, but

it should be gradually reduced to ensure banks’ stability and encourage

competition and access to ﬁ nance for SMEs. Supervisors should aim to

reduce the concentration of credit portfolios by gradually tightening limits

on credit concentration, and by subjecting banks that are exposed to high

credit concentration risk to additional capital requirements. Banks should

also be required to improve their risk management frameworks and apply

international best practices for loss reporting, collateral valuation, and

provision for NPLs.

Extension of the perimeter of prudential regulation will be increasingly

important. As ﬁ nancial systems become more diverse and complex, the

current focus on banking sector regulation and supervision will need

to be broadened. International experience shows that focusing on bank

regulation is not a sufﬁ cient instrument to capture systemic risks (Carvajal

and others, 2009). These considerations argue for the allocation of more

resources for regulatory authorities of nonbank ﬁ nancial institutions,

and for enhancing coordination among supervisors. Coordination is also

essential to prevent regulatory arbitrage as ﬁ nancial systems become more

diverse and complex.

Bank corporate governance

Building on recent progress, improving bank corporate governance is an

essential component of the ﬁ nancial sector reform program. Deﬁ ciencies in

bank corporate governance arrangements can pose systemic risks to the real

economy. ACT banks have made substantial progress in corporate governance

Bolstering Financial Stability and Development

over the past decade: setting up board committees (audit, accounting, and risk

management); separating the CEO and the chairman positions; diversifying

the composition of boards; setting up banking-sector-speciﬁ c corporate

governance (Egypt, Morocco, Yemen); and introducing guidelines and

regulation by supervisors (on the composition of the board, disclosure, risk

management, and connected lending).

There is still ample room for improvement, and signiﬁ cant challenges arise

for the implementation of reforms. Legislation and regulation on corporate

governance exist in most countries but their implementation is lagging

because supervisory authorities are weak. Audit committees are created by

banks, but they lack an adequate proportion of independent directors. Risk

committees are generally in place, but only at the management level.

Bank boards should be strengthened to include independent directors and

members experienced in banking and ﬁ nance issues. Results of an OECD-

Hawkamah survey suggest that boards in the ACTs should have a majority of

well-qualiﬁ ed independent or non-executive directors. Banking supervisors

need to deﬁ ne directors’ duties concretely and make sure that directors fulﬁ ll

their functions properly. The performance of board members should be

regularly evaluated. Board committees should receive adequate information

within the bank and be conducted by independent directors with clearly

deﬁ ned duties.

Improvements are needed in risk management and disclosure. Risk

management needs to be improved in most ACT banks, and requires creating

the position of chief risk ofﬁ cer (CRO), with adequate powers, who reports

directly to the board and alerts it to existing or emerging risks. Boards should

have a committee that establishes the salary structure for all bank employees

and board members. Although ﬁ nancial disclosure in the ACTs is largely of

good quality, nonﬁ nancial disclosure remains weak and needs to be improved,

particularly in areas of basic ownership structure, the qualiﬁ cations of board

members and their attendance at board and board committees, and related-

party transactions.

ACTs need a strategy for governance of state-owned banks. Although during

the past two decades the ACTs implemented comprehensive privatization

programs that included banks, during the past two decades, state-owned banks

still maintain a large share of total banking assets in most ACT countries

(Egypt, Libya, Tunisia). Countries should develop a vision for the role of

public banks and reduce ownership where government participation has no

clear and justiﬁ able objective. In this context, privatization should not be the

only option for state-owned bank reform, and ACT countries should consider

developing and implementing corporate governance standards for their state-

owned banks. Above all, state-owned banks should have clear objectives and

TOWARD NEW HORIZONS

performance criteria to allow for greater political autonomy and for enhanced

monitoring. Boards should include independent members with relevant skills

to approve and oversee the bank’s strategic decisions and the choice of senior

executives. Finally, to reinforce competition, bank supervisors should regulate

and supervise state-owned banks just as they regulate and supervise private

banks.

CHAPTER

Reform for Sustainable, Job-Creating,

Private Sector–led Growth

The ACTs have contended for years with structural economic challenges.

Many have moved over time from state-led economies to systems relying

more on private sector–led growth. Nonetheless, competition in domestic

markets and economic integration with the rest of the world remained

limited, public sector employment stayed much larger than in other regions

in the world, and the ACTs were unable to unleash the same economic

dynamism that helped to raise productivity growth and lead the economic

transformation in emerging markets and developing countries in other regions

(Lipton, 2004, 2012). As a result, per capita growth was lagging behind

other regions even before the onset of transitions in 2011 ( Figure 5.1 ). In

addition, there was a growing sense that the beneﬁ ts of economic growth

were largely captured by the well-connected, while large groups of people felt

marginalized. Not enough jobs were created for a growing population, leading

to high unemployment and low labor force participation ( Figure 5.1 ) (IMF, 2010).

Current demographic trends in the ACTs require a heightened focus on

growth and job creation. Demographic pressures suggest that unemployment

will remain high in the oil-importing ACTs unless growth accelerates above

6 percent. Under current baseline projections for GDP growth of around

4¼ percent in these countries through 2018, fewer than 5 million jobs

will be created, compared with about 7 million jobs needed to reduce the

unemployment rate halfway to the average of emerging markets (that is,

to about 8½ percent). To close this gap of 2¼ million jobs would require

an average annual growth rate of 6¼ percent, considering the currently

insufﬁ cient responsiveness of employment to growth. Because generating

such high growth will be difﬁ cult, a focus on increasing the responsiveness of

employment to growth is also needed. A strong commitment to creating an

environment where the private sector can generate high, sustainable, and more

job-creating growth will thus be required to improve labor market outcomes

and unlock the ACTs’ economic potential.

TOWARD NEW HORIZONS

As the political transitions are progressing, countries need to focus on

laying out plans for structural economic reform that will provide a vision

for revitalizing the economy. Strategies will vary with each country’s

different starting points and goals; and many countries, including Jordan,

Morocco, and Tunisia, can build on earlier successful economic reform

programs. All need to aim for higher, sustained, private sector–led growth,

which requires more private investment ( Figure 5.2 ) and higher productivity.

Governments should strive to engineer an environment conducive to

private sector–led growth, while ensuring adequate regulation for its

Figure 5.2 . More Investment is Needed to Support Growth

(National investment rate; percent of GDP)

Sources: National authorities; and IMF staff calculations.

Highest real GDP growth quartile among EMs.

2004 05 06 07 08 09 10 11 12 13

ACT avg.

EM avg.

High growth EMs¹

Figure 5.1 . Lagging Growth and High Unemployment

Source: IMF World Economic Outlook; World Bank World Development Indicators; and United Nations

International Labor Organization.

EGY

JOR

MAR

YEM

TUN

ACT

EMDC

LBY

MENA

World

0246

Private Investment (percent of GDP)

Real GDP per capita (annual percent change)

Real GDP Per Capita Growth and Private Investment,

2001–10

Beer

EGY

JOR

MAR

YEM

TUN

ACT

EMDC

World

MENA

0 5 10 15 20

Labor force parcipaon rate

Unemployment rate

Beer

Unemployment and Labor Force Parcipaon, 2001–10

(Percent)

Reform for Sustainable, Job-Creating, Private Sector–led Growth

efﬁ cient functioning, so that the economy can move from rent-seeking to

the creation of economic value and jobs. The ACTs themselves must drive

these transition agendas, but it is crucial that the international community

support them with adequate ﬁ nancing, improved access to key export

markets, and policy advice.

Bold reform agendas are needed to propel private sector activity and foster

a more dynamic, competitive, and inclusive economy. Taking into account

different country circumstances, reforms will broadly need to focus on four

areas: greater global and regional trade integration; business and investment

climate reforms to simplify doing business and enhance governance; labor

market and education system reform to ensure productive employment and

generation of human capital; and efﬁ cient safety nets to protect the poor

and vulnerable. These efforts need to be supported by a strong statistical

base that allows for efﬁ cient policymaking and monitoring. With a wide

ﬁ eld for potential reforms and limited implementation capacity, countries

will need to prioritize their reform efforts. Full implementation will take a

number of years, and early steps in areas with high payoffs are needed to

build momentum and signal governments’ commitment to reform, thereby

improving conﬁ dence (Yusuf, 2014). Country reform agendas will also need

to consider sectoral priorities for targeted growth strategies, while being

mindful of the perils of attempting to pick winners.

Boosting Trade

In recent decades, trade has not been a signiﬁ cant engine of growth for

ACTs. Merchandise exports as a share of GDP are signiﬁ cantly below

the average of emerging market and developing countries, and the gap has

widened over time ( Figure 5.3 ). As global growth has shifted toward emerging

markets, longstanding close links with Europe—particularly among North

African countries ( Figure 5.4 )—have meant that the region has beneﬁ tted

relatively little from the high growth of emerging markets, particularly in

Asia. Exports have also been inhibited in some cases by overvalued exchange

rates ( Chapter 3 ). Although countries (especially Morocco and Tunisia)

have streamlined and lowered their tariffs, these remain high, and there are

also signiﬁ cant non-tariff barriers ( Figure 5.5 ). Partly because of high trade

barriers between the ACTs, intraregional trade is very low ( Figure 5.6 ). Vested

interests from monopolistic or oligopolistic structures that provide rents to

inﬂ uential beneﬁ ciaries have often led to a political economy that has not been

conducive to comprehensive trade liberalization.

Progress toward transitioning into knowledge-intensive business services

and other higher-value-added areas has remained limited. The share of more

technologically advanced and higher-value-added capital goods in total exports

is small and remains below the average for low-income countries. This mirrors

TOWARD NEW HORIZONS

trends in the broader MENA region, where, according to recent estimates,

exports are only a third of their potential, and aggregate intra-industry trade,

an indicator of trade in differentiated goods and participation in supply

chains, is lower than in Africa and all other regions (Behar and Freund, 2011).

Deeper trade integration could provide a signiﬁ cant boost to the region’s

economies. Empirical evidence suggests that raising the MENA region’s

openness to the level of emerging Asian countries could increase GDP

growth by as much as a full percentage point (IMF, 2010). Deeper trade

Figure 5.3 . Large Potential for Higher Exports

(Merchandise exports; percent of GDP)

Sources: National authorties; and IMF staff calculations.

Excluding Libya.

1996–98 2006–8 2010–12

ACTs¹

Emerging and developing

Diﬀerence

Figure 5.4 . Strong Trade Links with Europe

(Exports to Europe, 2012)

Sources: National authorties; and IMF staff calculations.

Percent of total exports

Percent of GDP

Libya Tunisia Morocco Egypt Jordan Yemen

Reform for Sustainable, Job-Creating, Private Sector–led Growth

Figure 5.6 . Intraregional Share of Exports and Stock of Foreign Direct Investment

(2011 or latest available, percent)

Sources: ASEAN; MERCOSUR; IsDB; UNCTAD; Arab Investment

and Export Credit Guarantee Corporation; and national sources.

Exports

Foreign direct investment

Maghreb Mercosur Asean-5 Mashreq+GCC

integration would not only create growth and jobs through direct effects

on exports; it could also catalyze productivity-enhancing inward FDI.

Experience from Central Europe, for example, underscores that integration

into international supply chains can generate signiﬁ cant greenﬁ eld investment.

In addition, empirical studies show that larger markets are more successful in

attracting FDI; this would be another beneﬁ t of regional integration (IMF,

2013a). The drive toward deeper trade integration can also help catalyze

Figure 5.5 . Significant Trade Barriers

(Trade barriers, 2013)

Source: World Economic Forum, Global Competitiveness Report 2013–14.

Scaled from 1–7, with 7 being the least restrictive.

2.0

2.4

2.8

3.2

3.6

4.0

4.4

4.8

5.2

5.6

6.0

Egypt

Tunisia

Morocco

Jordan

Yemen

ACTs

Trade tariﬀs, percent

Prevalence of trade barriers¹ (right scale)

TOWARD NEW HORIZONS

reform efforts in other areas (such as business regulation and labor market

reform) that are important for successful trade integration. The move

toward greater integration into the global economy could thus help provide

discipline and incentives to enact broader reforms aimed at strengthening

competitiveness.

Deeper trade integration will require better access to advanced economy

markets. For instance, the EU’s high tariffs, quota restrictions, and farm

subsidies remain a signiﬁ cant impediment to agricultural exports to the EU,

and substantial non-tariff barriers to trade with the EU persist in the area of

standards and conformity assessments. Existing agreements with the EU also

do not provide for liberalization in trade in services. The EU could deepen

its trade relationships with the ACTs through effective implementation of

the proposed Deep and Comprehensive Free Trade Areas (DCFTA). As this

process will take time, immediate steps should include providing better access

for agricultural products (the EU has already adopted an agreement with

Morocco to that end) and dismantling non-tariff barriers. The United States

could deepen its existing trade agreements with Jordan and Morocco, and

enter into free trade agreements with the remaining ACTs.

More trade integration with the EU and the United States will become especially

important in the period ahead in light of the planned Transatlantic Trade and

Investment Partnership (TTIP). The TTIP, a planned agreement between the

United States and the EU, is expected to generate strong economic beneﬁ ts

overall but could have negative effects on ACT exports and jobs because of

expected trade diversion to countries inside the TTIP (Felbermayr and others,

2013), unless accompanied by better access for ACTs to EU and U.S. markets.

To fully reap the beneﬁ ts of integrating into global trade, a broader opening

to trade will be required. Many countries, including Morocco and Tunisia, are

strongly committed to further opening their trade regimes. All ACTs should

strive to reduce their non-tariff barriers and, building on past efforts, consider

further liberalizing their tariffs. They should also aim to diversify trade toward

fast-growing emerging markets and higher-value-added goods. They could also

better exploit the opportunities presented by global value chains, by removing

import barriers for their exporting industries. Increased regional integration

that would result from lowering non-tariff barriers and harmonizing policies

would also help the ACTs’ prospects for integration into global value chains.

The removal of import barriers will need to be implemented in a well-planned

manner, as the risk of negative short-term effects on affected industries

underscores the need for adequate social protection. Losses in budgetary

revenues stemming from lower tariffs would also need to be compensated by

increases in other revenues or expenditure cuts.

Trade facilitation policies also play an important role. Trade facilitation

measures can include the simpliﬁ cation of customs requirements, rules and

Reform for Sustainable, Job-Creating, Private Sector–led Growth

procedures, and upgrading logistics. These measures, which would also be

supported by the EU in the context of DCFTAs, are gaining importance in

a world of global value chains. Better logistics, in particular, have been shown

to promote exports. By one estimate, an improvement in Egypt’s logistics

quality to Tunisia’s level could increase Egypt’s exports by 12 percent (Behar,

Manners, and Nelson, 2013). Morocco has shown a large improvement in this

respect through investment in port infrastructure (including the expansion

of Tanger-Med to become the largest port in Africa) and in thinning out

obstructive procedures ( Figure 5.7 ). ACTs could also provide training for

small exporters and new entrants on navigating the variety and complexity

of rules governing trade, including standards and certiﬁ cation procedures.

Increased assistance from state overseas marketing agencies in identifying

export market opportunities and gathering relevant market intelligence would

be a considerable asset, especially for smaller companies.

A number of other export-promotion policy options can be considered.

These include export credits and insurance/guarantee schemes at below-

market rates (within the boundaries of existing trade agreements), transparent

tax concessions on earnings and proﬁ ts, targeted subsidies for nontraditional

exports, duty drawback provisions on imported inputs, and subsidies for

freight and transshipment fees to export markets. While these can help

support exports, they would need to be implemented in a transparent way in

order to preempt possible governance issues.

Recalibrating Business Regulation

The ACTs are encumbered with a legacy of complex and burdensome

business regulations. Egypt, for example, has catalogued 36,000 regulations

Figure 5.7 . Improvements from Trade Facilitation in Morocco

(Time to export and import; days)

Time to export

Time to import

2005 06 07 08 09 10 11 12

Source: World Bank Doing Business indicators.

TOWARD NEW HORIZONS

affecting the private sector, many of which overlap, originating from—and

implemented by—different parts of government (Amin and others, 2012).

The results are often lengthy, expensive, and complicated procedures for

starting and operating businesses: an average of 22 percent of ﬁ rms in the

ACTs perceive business licensing and permits as a major constraint to their

activities, by far the highest share among the world’s regions, though the share

is substantially lower in Morocco ( Figure 5.8 ).

In addition to constraining entrepreneurial activity and private investment,

complex and burdensome regulation is also conducive to informality and

corruption. The informal sector is larger than in other middle-income

countries, with estimates ranging from 26 percent to 44 percent (IMF, 2011d).

Opportunities for business growth and investment are more limited in the

informal sector, and many workers have little or no social protection or

employment beneﬁ ts. Most countries in the region fare poorly on global

governance rankings—increasingly so over the past decade ( Figure 5.9 ).

Corruption is a major concern, with more than half of ﬁ rms in the MENA

region having experienced bribe payment requests, a much higher share than

in any other region in the world.

Unclear rules and discretion in business regulation have also limited enterprise

creation and turnover. Firms in the MENA region tend to be substantially

older than in other emerging market and developing countries, and only the

World Bank Enterprise Surveys (http://www.enterprisesurveys.org).

Ibid.

Figure 5.8 . Business Licensing and Permits are Major Constraints

(Percent)

Source: World Bank Enterprise Surveys 2006–11.

Percent of firms identifying business licensing and permits as a major

constraint.

JOR

EGY

MAR

YMN

E. Asia/Pac.

EE&CA

LATC

MENA

OECD

S. Asia

SSA

World

ACT average

Reform for Sustainable, Job-Creating, Private Sector–led Growth

East Asia/Paciﬁ c region has fewer registered ﬁ rms per capita (World Bank,

2009). High barriers to entry and protected markets constrain competition

and, consequently, growth and employment.

There is a widespread perception in the region that the private sector is

rent-seeking and corrupt. In addition, ofﬁ cials are often perceived as being

selective in improving the investment climate for the beneﬁ t of a few well-

connected ﬁ rms, families, and institutions (World Bank, 2009).

Countries have already taken action. A drive for regulatory reform in the

ACTs, that had begun prior to the transitions, has helped raise business

entry rates, private investment and FDI; many ACTs are now relatively well-

positioned in the World Bank’s Doing Business rankings, considering their

levels of per capita income ( Figure 5.10 ).

There is, however, much room for

improvement. Since the onset of the transitions, reform efforts have been

mixed, with some countries falling back in the rankings, and others renewing

efforts at reviewing regulations ( Figure 5.11 ). Morocco, in part through

the efforts of its Comité National de l’Environnement des Affairs (CNEA), was

named the country with the most improved business regulations in the World

Bank’s 2012 Doing Business rankings. Reforms since 2011 have included, for

example, a reduction in the minimum capital requirement and fees for starting

a business in Jordan and Morocco, and enhanced electronic ﬁ ling options for

tax documents in Morocco.

Sustained and intensiﬁ ed efforts are needed. There is an urgent need to

accelerate the reform process, which is key to job creation in the medium

World Bank Doing Business Indicators.

Figure 5.9 . Governance and Corruption are Increasingly Serious Concerns

(Percentile, 2000 and 2012)

Source: World Bank, Worldwide Governance Indicators.

Government

Eﬀecveness

Regulatory

Quality

Rule of Law Control of

Corrupon

Beer governance

ACTs 2000 average

ACTs 2012 average

TOWARD NEW HORIZONS

Figure 5.10 . Doing Business Rankings Improve with Income

Sources: IMF World Economic Outlook; World Bank Doing Business 2014 ;

and IMF staff calculations.

2013.

Note: Countries with PPP GDP pc above $25,000 have been excluded.

EGY

JOR

MOR

TUN

YMN

120

160

200

0 5,000 10,000 15,000 20,000 25,000

Doing Business Ranking

PPP GDP per Capita (2013, billions of U.S. dollars)

Figure 5.11 . Doing Business Reform Efforts Have Been Set Back

(Number of Doing Business reforms)

Source: World Bank Doing Business 2008–14.

2007 08 09 10 11 12 13

YMN

TUN

MAR

JOR

EGY

term. In particular, it is essential to create systems of checks and balances

in national and regional institutions to prevent the exercise of excessive

discretion and nontransparent intervention. The experience of East Asia,

for example, shows that countries that were effective in creating accountable,

rules-based institutions were signiﬁ cantly more successful at generating

economic growth than countries where institutions remained subject to

arbitrary intervention by political leaders and public ofﬁ cials (World Bank,

Reform for Sustainable, Job-Creating, Private Sector–led Growth

2009). Moreover, policymakers will need to strengthen incentives for the large

informal sector to integrate with the formal economy. However, despite such

efforts, the informal economy will remain large over the medium term, and

policymakers should also increasingly focus on raising productivity in the

informal sector as such.

Institutional and regulatory reforms should aim at:

•

Reducing the scope for discretion

, by, for example, reducing the

number of administrative steps in interactions with businesses and

orienting interactions toward electronic processes.

•

Improving transparency and access to information

, to promote

accountability of public institutions.

•

Strengthening the autonomy of institutions from the executive and

political leaders

, to help reduce undue interference.

•

Putting in place independent evaluation of the performance of

institutions.

Strategies to reform business regulation should focus on removing the

barriers to entry and exit. Entry requirements—such as sector-ministry

approval, that give ofﬁ cials substantial discretion over which investors to

favor or exclude—should be reviewed and based on clear and transparent

rules. Similarly, high minimum capital requirements and restrictions on

foreign ownership should be relaxed, unless they reﬂ ect a particular

regulatory concern. In addition, the focus of reform efforts should be

on removing difﬁ culties to exit, including modern bankruptcy codes that

decriminalize business failure.

Countries should place special emphasis on providing an enabling

environment for SMEs and startups. Given the importance of SMEs’

contribution to output and employment in the ACTs, special focus on

providing an enabling environment for them will be needed. For startups,

in addition to an enhanced emphasis on access to ﬁ nance ( Chapter 4 ),

countries should aim at building a broader ecosystem that helps young

entrepreneurs progress and gain a foothold in the economy.

Improving Labor Markets and Education

Labor markets face substantial problems. The ACTs’ high rates of

unemployment are compounded by signiﬁ cant demographic pressures as

more of the young population enters the labor market (Ahmed, Guillaume,

TOWARD NEW HORIZONS

and Furceri, 2012) ( Figure 5.12 ). Youth unemployment is high, ranging

from 18 percent to 30 percent in Egypt, Jordan, Morocco, and Tunisia. In

Egypt, the share of ﬁ rst-time job seekers ﬁ nding employment in a formal job

dropped from 80 percent in the 1970s to 30 percent in the mid-2000s, and

those entering the labor force in a public sector job do so after having spent

an average 2.3 years in unemployment (Amin and others, 2012).

Source: World Bank Enterprise Surveys 2006–11.

Percent of firms identifying each item as a major constraint.

World

Dev. Eco.

and EU

C. and S.E. Eur.

E. Asia

S.E. Asia

LAC

MENA

SSA

Jordan

Egypt

Morocco

Tunisia

Yemen

ACT

4 6 8 10 12 14 16 18 20

Youth unemployment rate

Total unemployment rate

Beer

Figure 5.12 . Excess Labor Regulations and Education Mismatches

(Percent)

Figure 5.13 . Large Total and Youth Unemployment

(Rates by region, 2012; percent)

Sources: International Labor Organization; national authorities; and IMF

staff calculations.

Egypt, Jordan, Morocco, Tunisia, and Yemen.

Note: EE&CA = Eastern Europe and Central Asia; SSA = Sub-Saharan Africa.

Beer

JOR

EGY

MAR

YMN

E. Asia/Pac.

EE&CA

LAC

MENA

OECD

S. Asia

SSA

World

0 5 10 15 20 25 30

Inadequately educated workforce

Labor regulaons

Reform for Sustainable, Job-Creating, Private Sector–led Growth

Women face particular problems entering the formal labor market and securing

employment. In Egypt, Jordan, Libya, Morocco, and Tunisia, only about a

quarter of adult women are in the labor force compared to 70–80 percent

labor participation rates among men (AfDB, 2012b).

Recent analysis shows

that, for the broader MENA region, if the gap in female labor participation

during the last decade had been double instead of triple the average gap in

emerging markets, the region could have gained $1 trillion in cumulative

output, doubling GDP growth (IMF, 2013d).

The roots of the problems vary across countries, but a number of common critical

factors have been identiﬁ ed in labor markets and education. These include: stiﬂ ing

labor market regulations; the dominance of the public sector as employer of ﬁ rst

and last resort; and education systems that do not deliver an adequate skill mix.

•

Rigid labor market regulations

discourage ﬁ rms from hiring. Enterprise

surveys show that 23 percent of ﬁ rms in the MENA region perceive

labor regulations as a major constraint, by far the highest share among

the world’s regions ( Figure 5.13 ). A survey of manufacturing ﬁ rms in

Egypt found that 24 percent would increase their hiring in the absence

of restrictions, while only 3 percent would ﬁ re workers (AfDB, 2012b).

Regulations affecting layoffs of workers are particularly restrictive in

the region. In Tunisia, for example, rules and procedures for laying off

workers for economic and technological reasons are complex and rarely

used (AfDB, 2012a). As a result, economic activity is diverted to the

informal sector, where workers do not enjoy the same level of protection.

Empirical estimates show that labor market rigidities can explain nearly

30 percent of the size of the informal economy in the ACTs (IMF, 2011d).

•

The dominance of the public sector in the labor market

( Figure 5.14 )

has introduced distortions by affecting the structure of unemployment

and the supply of skills through the education system. The (implicit

and explicit) employment guarantees in government hiring, and

mismatched salary expectations resulting from generous civil service

pay scales and beneﬁ ts, have led to market segmentation and excess

demand for public sector jobs ( Figure 5.15 ).

•

The education system’s strong focus on formal qualiﬁ cations for

entry into the civil service

has meant that job market entrants often do

not have the right skills mix for the private sector. Enterprise surveys show

that the share of ﬁ rms in MENA identifying an inadequately educated

workforce as a major constraint (39 percent) is the highest among the

world’s regions ( Figure 5.13 ). In Egypt, for example, a study found that

34 percent of jobs require a technical education, but only 11 percent

Data for male and female participation in the informal sector, such as traditional agriculture, are not available .

TOWARD NEW HORIZONS

Figure 5.14 . The Public Sector is a Large Employer in MENA

(Public sector employment as a share of total employment, 2008 – 11; percent)

Sources: National authorities; International Labor Organization;

IMF World Economic Outlook database; and IMF staff calculations.

AE: Advanced economies; CCA: Caucasus and Central Asia; CEE:

Central and Eastern Europe; DA: Developing Asia; LAC: Latin

America and the Caribbean.

DA CCA LAC AE CEE ACTs EGY JOR TUN YMN

Figure 5.15 . Government is the Preferred Employer for Arab Youth

(Arab youth employment preferences; percent)

Source: Burson-Marsteller, 2013.

Egypt Jordan Libya Morocco Tunisia Yemen

Government Private sector Undecided

of graduates have this level of qualiﬁ cation (Kandil, 2012). University

education, meanwhile, is skewed away from technical subjects. Across

North Africa, only 18 percent of university graduates are in the ﬁ elds of

science and engineering (AfDB, 2012b). In addition, while public spending

on education as a percent of GDP has been higher in the MENA region

Reform for Sustainable, Job-Creating, Private Sector–led Growth

than in comparable East Asian and Latin American countries, the return

in terms of the quality of education have been disappointing: MENA

country rankings in international educational achievement tests remain

low (Amin and others, 2012). Primary education is also an area in need of

improvement, underscored by low literacy rates, for example, in Egypt,

Morocco, and Yemen, and undermining labor productivity.

Solutions to these problems will vary among countries. Bearing in mind

countries’ different problems and starting conditions, solutions should

generally be centered on ﬁ ve areas: reviewing labor market regulation to

reduce disincentives for hiring, while maintaining adequate worker protection;

revisiting public sector hiring practices and compensation policies to

reduce the public sector’s labor market dominance and bias; reforming the

education system, aligning it better with the needs of private employers;

pursuing active labor market policies to make quicker inroads in lowering

unemployment; and placing particular emphasis on policies promoting youth

and female employment.

Many of these reforms are complex and will require

considerable efforts at consensus-building and implementation.

•

Reviewing labor market regulation

with a view to reducing

distortions—particularly those that discourage hiring and skill building—

while ensuring adequate social protection. Regulations should continue

to provide appropriate protection against discrimination and arbitrary

decisions by employers, thereby promoting efﬁ ciency by providing

incentives for employers and employees to invest in ﬁ rm-speciﬁ c training.

By contrast, undue protection, including cumbersome processes for

layoffs and excessive severance payments, should be reduced or phased

out, to relieve ﬁ rms of excessive rigidities in a constantly changing

economy, and the associated negative effects on labor demand and

economic growth. Minimum wages should also be reviewed under a

transparent mechanism, setting them low enough to support demand for

low-skilled workers, but high enough to support the bargaining position

of workers and limit discrimination.

•

Revisiting public sector hiring policies

to ensure that hiring does

not exceed the needs and/or means of the public sector. At the same

time, compensation policies may need to be revised to reﬂ ect worker

productivity and comparable salaries in the private sector. As the model

of the state as employer of ﬁ rst and last resort is phased out, prospective

job market entrants will have an incentive to position themselves

increasingly toward the private job market.

See also work on this issue in IMF Regional Economic Outlook for the Middle East and Central Asia (IMF 2010,

2011b, and 2011d).

TOWARD NEW HORIZONS

•

Improving and reorienting the education system

will also help

address labor market mismatches. There is scope to align curricula better

with the needs of the private sector, including through an increased

focus on writing skills, critical thinking, and problem solving. This

can be approached by partnering with the business community to

reform the curricula, and further catalyzed by increasing school’s public

accountability by giving citizens adequate mechanisms to inﬂ uence

education objectives, priorities, and resource allocation (World Bank,

2008b). In addition, relating the hiring of government employees more

to individual productivity and skills than to credentials would create

incentives to reorient the education system toward more productive and

demanding curricula.

•

Focusing on short-term policies to improve labor market outcomes

will be equally important, as many of the other reforms take time to

implement and yield results. Such policies notably include active labor

market policies, such as job intermediation and placement services,

apprenticeship and training programs (including entrepreneurship

training), employability training, and support for on-the-job training.

Egypt, Jordan, and Tunisia, for example, have government-funded active

labor market programs, though so far these reach only a limited number

of beneﬁ ciaries.

•

Promoting employment of women and youth

. Female employment

can be supported by offering more ﬂ exible work schedules,

accommodating needs such as reduced ability to travel and child care

responsibilities, improving girls’ access to education, and by offering

programs speciﬁ cally for women (IMF, 2013d). Programs for youth can

include training and counseling for labor market entry, and internship

schemes to smooth the transition from school to work.

Creating More Efﬁ cient Safety Nets

Despite progress over the past two decades, poverty remains an important

concern, particularly among children and in rural areas ( Table 5.1 ) (World

Bank, 2012c). Early childhood malnutrition rates are high, and children

in poor households are more likely to drop out of school and thus bring

limited skills to the job market. Rural poverty rates ( Figure 5.16 ) are in some

countries more than twice those of urban areas. Limited access to basic

services, including health and education, restricts opportunities for many of

the poor. In addition, in some countries, a signiﬁ cant share of the population

is vulnerable to falling into poverty ( Figure 5.17 ); with incomes just above

the poverty line, these households cannot adjust their expenditures when

Reform for Sustainable, Job-Creating, Private Sector–led Growth

Table 5.1 . Poverty Remains an Important Concern

(Overall and child poverty rates; percent)

Overall Child (0–14)

Egypt 2013/2011 26.3 26.4

Jordan 2010 14.4 20.1

Morocco 2010 20.0 25.0

Yemen 2006 34.8 36.0

Sources: National authorites; UNICEF; and World Bank (2012c).

Figure 5.16 . Rural Poverty is Significant

(Poverty rate of rural population; percent)

Source: World Bank (2012c).

0 1020304050

Yemen

Iraq

Egypt

Tunisia

Jordan

Figure 5.17 . Many People are Vulnerable to Falling into Poverty

( Share of population living between $2 – $2.5 a day; percent)

Source: World Bank (2012c).

0 5 10 15 20

Jordan

Tunisia

Morocco

Yemen

Egypt

TOWARD NEW HORIZONS

necessary. Yet few have access to formal safety nets, and those without access

face a higher risk of moving into poverty.

Spending on subsidies for food and fuel is a costly and inefﬁ cient means

of social protection. The ACTs have been relying heavily on subsidies as

their main tool for providing social protection. Generalized energy price

subsidies, in particular, are large, and though they provide support for poor

consumers, they disproportionately beneﬁ t the well-off. Energy subsidies

are appealing to governments because they are easier to administer than

other means of social protection; however, they weigh heavily on public

ﬁ nances in an environment of high deﬁ cits and debt, and crowd out

resources for targeted social programs. In all ACTs, energy subsidies take a

larger share of the resource envelope than, for example, public spending on

education.

In contrast to subsidies, social safety net (SSN) programs are small. They

account for only about one-tenth of spending on subsidies in the ACTs

( Figure 5.18 ), and reach less than one-third of the population in the lowest

income quintile ( Figure 5.19 ), signiﬁ cantly below the world average.

SSN spending is poorly targeted. The ACTs’ tendency to rely on geographical

and categorical targeting does not work well in environments where

poverty is less concentrated in certain regions or demographic groups. As a

consequence, only a quarter of recipients of SSN beneﬁ ts are in the lowest

income quintile, far below the world average. Nonetheless, there are also

notable improvements under way in the ACTs: Jordan and Yemen have

Figure 5.18 . Social Safety Nets are Small

(Spending on social safety nets and subsidies; percent of GDP)

Sources: World Bank (2012c); IMF Fiscal Affairs Department database;

IMF staff reports, various publications; and IMF staff estimates.

0.0

3.0

6.0

9.0

12.0

MENA

EMDCs

Tunisia 2011

Jordan 2011

Morocco 2008/9

Egypt 2009

Yemen 2013

Food and fuel subsidies

Social safety nets

Reform for Sustainable, Job-Creating, Private Sector–led Growth

introduced SSN programs with elements of means testing or proxy means

testing—i.e., based on attributes that correlate with poverty—which are

expected to yield better results.

There is limited awareness of SSNs among the groups that should beneﬁ t the

most from them. People in the bottom income quintile are much less aware

of SSN programs than people in the top quintile ( Figure 5.20 ). According to

surveys, almost a quarter of Egyptians are not aware of any SSN programs,

while in Tunisia, people in the top and middle income quintiles are much

more likely than the poor to personally know SSN beneﬁ ciaries.

Figure 5.19 . Social Safety Net Coverage is Limited

(Percentage covered in bottom income quintile)

Source: World Bank (2012c).

Yemen 2005

Jordan 2010

Morocco 2010

Egypt 2009

MENA

World

E. Asia & Paciﬁc

Eur. & Cent. Asia

L. Amer. & the

Caribbean

Figure 5.20 . Limited Awareness of Social Safety Nets in the Lowest Income Quintile

(Average number of SSN programs recognized by respondents, 2012)

Source: World Bank (2012c).

Egypt Jordan Tunisia

Lowest income quinle

Highest income quinle

TOWARD NEW HORIZONS

As a result, SSNs have little impact on poverty and inequality. The small size,

low coverage, poor targeting, and limited awareness among those in need

mean that the impact of these programs on poverty and inequality is small.

Except in Jordan, the impact of SSNs on reducing poverty is well below the

world average.

A roadmap for reform

The strategy for reform should be centered on phasing out generalized

subsidies and replacing them with more efﬁ cient SSNs. In light of their

inefﬁ ciencies as means of social protection, there is a strong case for phasing

out generalized subsidies. Scaled-up and appropriately targeted SSNs have the

potential to deliver much more cost-effective social protection, freeing scarce

resources for other priority expenditure and debt reduction.

International experience shows that subsidy reform is often difﬁ cult to

implement. Countries attempting reform have often faced obstacles (IMF,

2013a): these include a lack of public information and understanding of

the magnitude and ineffectiveness of subsidies; opposition from speciﬁ c

groups beneﬁ ting from subsidies (for example, transport sector, energy-

intensive manufacturing); lack of public trust that governments will use

the savings from subsidy reform efﬁ ciently for alternative means of social

protection, other priority expenditure, or debt reduction; concerns regarding

a possible net adverse impact on the poor; concerns about effects on inﬂ ation

and volatility of prices, beyond energy products; loss of competitiveness,

especially in energy-intensive sectors; and weak macroeconomic conditions at

the outset of reforms exacerbating many of the above concerns.

In that light, it will be important to plan subsidy reform well. Country

experience highlights six factors that heighten the chances for success

(IMF, 2013b, 2014):

•

Targeted mitigating measures for the poor

, which are discussed below;

•

A comprehensive energy sector reform plan

, drawn up in consultation

with stakeholders;

•

A comprehensive communications strategy

, including consultation

with stakeholders, provision of information on the costs of subsidies and

beneﬁ ts of reform, and heightened transparency in reporting subsidies

in the budget;

•

Appropriately phased in and sequenced price increases

that avoid

sudden and sharp increases;

Reform for Sustainable, Job-Creating, Private Sector–led Growth

•

Improved efﬁ ciency of state-owned enterprises

to reduce producer

subsidies; and

•

Depoliticized price setting

through price liberalization or rules-based

price-setting mechanisms.

The substantial incidence of poverty, the limited scope and efﬁ ciency of

existing SSNs, and the need to reform generalized price subsidies suggest a

need to expand SSNs and make them more efﬁ cient, by:

•

Increasing spending on SSNs and improving their coverage

creating new programs, and expanding existing ones that are effective.

•

Simplifying the SSN landscape by consolidating fragmented SSN

programs

into a few comprehensive programs speciﬁ cally designed to

reach different segments of the poor and vulnerable populations.

•

Investing in SSN infrastructure

by creating uniﬁ ed registries of

beneﬁ ciaries that can be used across multiple programs, and by using

modern service delivery mechanisms such as smart cards, mobile

payments, and over-the-counter payments in bank branches.

•

Prioritizing interventions that strengthen human capital

, including

conditional cash transfer programs and workfare programs.

• Increasing the use of proxy means testing in targeting social

assistance (where feasible in light of administrative capacity issues

and possible political sensitivities) , which has been shown to be more

effective at targeting the poor and vulnerable than geographic or

categorical criteria.

•

Focusing on strong governance and accountability in SSNs

improve their efﬁ ciency and minimize corruption.

•

Reaching out and informing the poor and vulnerable

about the

safety net programs available to them.

Several ACTs are already making progress in these areas. Morocco has started

to consolidate its SSN programs and has scaled up its successful Tayssir

program, a conditional cash transfer program for families with school-aged

children. Yemen reformed its Social Welfare Fund by scaling it up, introducing

See World Bank, 2012c for more details.

TOWARD NEW HORIZONS

a proxy means test formula, and strengthening capacity in service delivery.

Jordan is moving in the direction of poverty-based targeting and, in the

context of the 2012 fuel subsidy reform, implemented a cash transfer system

to compensate a large part of the population.

Most ACTs are currently considering new programs or reforms in their

existing SSNs. Egypt intends to expand priority social programs and

implement targeted cash transfer programs. Morocco continues to expand

the coverage of the Tayssir program and the RAMED program (basic health

coverage for the poor). Tunisia also plans increased cash transfers to targeted

households. Yemen plans to further increase its support to the poor through

the Social Welfare Fund.

Further efforts are needed to improve social outcomes and support the

economic transitions. While countries have begun to reform their safety nets,

substantially more efforts are needed to improve and modernize them, and,

by making them more efﬁ cient, free scarce resources for priority expenditures

and deﬁ cit reduction.

Strengthening Economic Statistics

The global ﬁ nancial crisis has shown the importance of preemptively

identifying sources of ﬁ scal and ﬁ nancial sector risks to support

macroeconomic stability and inclusive growth. The ACTs have made

signiﬁ cant progress in strengthening their statistical systems, and Egypt,

Jordan, Morocco, and Tunisia subscribe to the IMF’s Special Data

Dissemination Standard (SDDS). Nonetheless, the ACTs need further

development of national accounts, government ﬁ nance, balance of payments,

monetary, and ﬁ nancial statistics to improve their availability, coverage,

periodicity, and timeliness. On the positive side, ACTs have begun adopting

the methodologies of the IMF’s Government Finance Statistics Manual 2001 ;

however, the ofﬁ cial coverage of ﬁ scal statistics could be expanded beyond

central government statistics to the social security system, other extra-

budgetary funds, and sub-national government accounts ( Chapter 2 ). The

coverage of state-owned enterprises and government ﬁ nancial institutions

also remains limited, except in Morocco and Egypt. Balance of payments

statistics could generally beneﬁ t from greater details on the ﬁ nancial accounts.

Addressing the challenges in banking supervision information systems and

database management would help increase accuracy and reduce the signiﬁ cant

lags in reporting ﬁ nancial indicators. On national accounts, additional efforts

are needed to develop national accounts from the expenditure approach, and

to produce high-frequency data on employment, unemployment, and wages,

as well as the coverage of informal activities.

CHAPTER

Managing Economic Change During

The Transitions

Generating success in economic transformation requires a coordinated

effort. The complexity of the task under adverse conditions necessitates a

heightened focus on navigating the political economy and a strong

communication strategy. Careful sequencing of reforms will be required,

with emphasis on early steps in areas with high payoffs, and countries need

to employ a ﬂ exible approach so they can seize reform opportunities as

they arise. Well-coordinated and stepped-up support from the international

community is also essential.

Political economy and communications

The ACTs are embarking on difﬁ cult macroeconomic and structural reforms

in a challenging socio-political environment ( Figure 6.1 ). Policymakers across

the ACTs are facing a difﬁ cult economic situation that is making the need

for reforms urgent in a broad range of areas, even as the socio-political

environment challenges policymakers’ ability to deliver them:

• The political transitions are complex , with a number of countries

yet to adopt new constitutions and elect governments with more than

transitional terms.

• Institutional uncertainty adds to political risks . Lack of clear

relationships between different institutions, together with weak or even

absent institutions, hinders the reform process and delays the economic

transformation agenda.

• Governments with short horizons and looming elections have

limited mandates or incentives to undertake reforms that have

short-term political costs—irrespective of their future beneﬁ ts.

For example, transitional governments may ﬁ nd it difﬁ cult to implement

subsidy reform or allow for exchange rate depreciation that would have

TOWARD NEW HORIZONS

negative income or balance sheet effects for some groups in the short

term, even though these measures are necessary to strengthen inclusive

growth in the future.

• Many reforms have important distributional impact, which can

trigger early resistance . Some vested interests have been weakened

in the context of the transitions, but other interest groups may be in

a better position to inﬂ uence economic policy than newcomers. Moreover,

the struggle for power and rents between the former elite and vested

interests on the one hand, and the newcomers on the other, increases

political uncertainty and may also discourage reform efforts.

• Although coalition governments are in place in a number of ACTs,

parties within the coalition may have conﬂ icting agendas. This

conﬂ ict can jeopardize reforms that have important distributional effects.

In addition, a lack of experience among those new to government often

poses obstacles to the design and implementation of reforms.

• Youth interests can no longer be treated as an “ add-on. ” The

demographic situation in the MENA region, where youth make up the

majority of the population, needs to be factored into the decision-making

process, and youth interests need to be explicitly addressed. According

to a recent survey, a large share of youth in the ACTs is dissatisﬁ ed with

the direction of the economy ( Figure 6.2 ) (Burson-Marsteller, 2013).

Moreover, Arab youth have traditionally borne a disproportionate share

of the costs of economic adjustment during previous decades.

Figure 6.1 . Political Risk Has Increased

(Ranges from 100 (least risk) to 0 (highest risk))

Source: The PRS Group.

Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13

Egypt Jordan Libya

Morocco Tunisia Yemen

Arab Spring begins

Managing Economic Change During The Transitions

• The security situation has deteriorated in most ACTs. Polarization

has increased among different groups—political, ethnic, religious,

and economic. Sources of discontent—most notably high youth

unemployment—are still unresolved and have in many cases grown

worse. Spillovers from regional conﬂ icts are aggravating polarization and

security challenges.

In addition, governments have inherited economic institutions that require

strengthening.

• The rule of law is the overarching prerequisite for institutions and

governments to gain the trust of investors and citizens alike , and there

remains considerable room for improvement in this area ( Figure 6.3 ). This

problem is exacerbated by a considerable gap between the establishment

of rules and their application following a long period of institutional

stagnation or even decay in some ACTs. International experience shows

that, in countries undergoing political transition, the process of establishing

the rule of law is often at risk, because emphasis tends to be placed on the

most pressing, immediate requirements of a functioning democracy:

enacting a constitution and holding periodic elections.

• A merit-based civil service is required to step up government

effectiveness and enable change. The ACTs lag in this respect, because

the civil service in many cases has lacked the incentives and training to

manage increasingly complex public policy decisions. In addition, in

Figure 6.2 . Perception of Arab Youth about Direction of the Economy

(Percent)

Source: Burson-Marsteller, Arab Youth Survey, 2013.

Egypt Jordan Libya Morocco Tunisia Yemen

Right Wrong

See International Crisis Group (2012).

TOWARD NEW HORIZONS

several ACTs, the perception of government effectiveness—the reach

and quality of public services, the professionalism and independence of

the civil service, the quality of policy formulation and implementation,

and the credibility of the government’s commitment to such policies—

has declined over time ( Figure 6.4 ).

• Budgetary institutions with rules that govern budget formulation,

execution, reporting, and disclosure, along with capable external

oversight bodies, are necessary to support sound ﬁ scal policy and

ﬁ nancial accountability ( Chapter 2 ); but countries, including those that

have undergone a Public Expenditure and Financial Accountability

(PEFA) assessment, show signiﬁ cant shortcomings.

• Central bank independence is critical for the credibility of monetary

policy, but few countries in the region have achieved it, partly because of

ﬁ scal dominance ( Chapter 3 ).

• An independent competition body is also needed to facilitate business

entry and operation in all sectors of the economy, contain monopolistic

tendencies, and foster economic efﬁ ciency.

Figure 6.3 . Rule of Law Ranking Shows Room for Improvement

(Percentile ranking among 215 countries; ranges from 100 (highest) to 0 (lowest))

2010 2011 2012

GCC

Average

Jordan Tunisia Egypt Morocco Other

MENA

Average

Libya Yemen

Source: World Bank World Governance Indicators, 2013.

Includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.

Includes Algeria, Djibouti, Iran, Iraq, Kuwait, Lebanon, and Mauritania.

The percentage of indicators with low ratings (C and D) is 25 percent for Tunisia ( June 2010), 39 percent for

Morocco (May 2009) and 56 percent for Yemen ( June 2008).

Managing Economic Change During The Transitions

• Informal institutions need to be taken into account. Informal

networks—for example, those driven by personal relations or

patronage—are still prevalent, especially in countries lacking efﬁ cient

social safety nets, and can affect the reform process in unforeseen ways.

The feasibility of reforms may also be constrained by limited administrative

capacity to design and administer them. Agents of change who are needed

to champion reform could be at risk of becoming overloaded and losing the

ability to focus on delivering on priority items. Complex reforms may therefore

not be feasible in the short term, and would require careful sequencing that

includes investment in building the capacity to implement them.

The strategy for undertaking reforms must be tailored to the particular

circumstances of each country as well as to the speciﬁ c nature of the reforms.

There is no one-size-ﬁ ts-all approach; nonetheless experience gleaned from the

work of the IMF and other institutions, as well as the political economy literature,

points to a number of considerations that policymakers in the ACTs may ﬁ nd

useful when designing and implementing reforms.

Figure 6.4 . Government Effectiveness Has Suffered in Most ACTs

(Percentile ranking among 215 countries; ranges from 100 (highest) to 0 (lowest))

Source: World Bank World Governance Indicators, 2013.

Includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.

Includes Algeria, Djibouti, Iran, Iraq, Kuwait, Lebanon, and Mauritania.

2010 2011 2012

GCC

Average

Tunisia Jordan Morocco Egypt Other

MENA

Average

Yemen Libya

See OECD (2010); Fritz and others (2008); and Haggard and Webb (1993).

TOWARD NEW HORIZONS

Creating a sense of urgency for reform can boost the chances of success.

A strong case must be made for the beneﬁ ts of reform. Gathering data

and undertaking analytical work to explain poor outcomes, and identifying

policies to improve them, are the ﬁ rst steps in a well-designed reform

process. Highlighting the costs of the status quo and providing evidence of

the beneﬁ ts of reform across the different segments of the population can

provide a compelling case for change. For example, recent analytical work

has shown that generalized energy subsidies are ﬁ scally unsustainable and

socially unfair, supporting the case for change ( Chapter 2 ).

Reform plans should be anchored in clear and measurable performance goals.

By increasing transparency and holding policymakers accountable for reform

implementation, one can lessen the risk of reform paralysis in which reform is

much discussed but never implemented.

A participatory approach can reduce resistance to change. As policymakers

across the ACTs formulate and embark on their reform agendas, different

stakeholders—new and emerging political actors, parliamentarians, academics,

businesses, organized labor, civil society, youth activists, think tanks, and

policymakers themselves—will have varying perspectives on the way forward.

To build momentum for reform, transparency about the whole reform

process is essential. Policymakers’ success will depend on listening to all

stakeholders’ views when formulating policy agendas. This will require legal

reforms to permit independent organizations to form without state approval.

A more participatory process will help identify areas of resistance or support

for change. Experience shows that involving a broader spectrum of society

in the design of reform—along with a readiness to respond to concerns to

the extent of modifying reform proposals—also fosters a sense of ownership

for reform and can help hold back future opposition. Moreover, reform

experiences in OECD countries indicate that, although consultative processes

are no insurance against conﬂ ict, they can generate greater trust among

parties involved, which “may make expected losers more willing to rely on

commitments to measures that will mitigate the cost of reform to them”

(OECD, 2010).

Building coalitions is imperative for successful reform. Economic reform

inevitably entails distributional consequences: losses for some—particularly

those with vested interest in the status quo —in the short term, while generating

broad beneﬁ ts to the wider population only in the longer term. Gaining

traction for reform—and ultimately succeeding in implementing it—depends

to a great extent on a government’s ability to build coalitions in support

of change while addressing opponents’ concerns about its distributional

impact ( Box 6.1 ).

Managing Economic Change During The Transitions

Careful timing and sequencing are also required. In a challenging socio-

political environment, it may be necessary to move ahead with those

measures that can garner sufﬁ cient support and to postpone others: some

progress is better than none at all. In this sense, it will be important to

accept deviations in timing and sequencing from technically or economically

“optimal” reform paths, subject to considerations of macroeconomic stability.

Policymakers may focus on low-hanging fruit or use small-step approaches,

such as launching reforms on a limited scale and assessing them before

expanding them. Examples include accepting a gradual approach to a tax

increase, or linking electricity tariff increases to improvements in service

provision coverage. In the case of particularly difﬁ cult reforms, such as the

introduction of exchange rate ﬂ exibility, for example, success is more likely to

be secured when a government’s political mandate is strong and the potential

loss of political capital is manageable, which in many instances is after

elections (Rother, 2009).

Box 6.1 . A Stylized Approach to Building Coalitions

This approach entails coalescing

with champions (high-inﬂ uence

groups that support the measure),

empowering winners (low-

inﬂ uence groups that beneﬁ t from

the reform) and helping them

voice their support, compensating

or defusing inﬂ uential groups

that would lose as result of the

reform, and compensating the

most vulnerable that would lose

and have little inﬂ uence. Well-

targeted measures for protecting

the latter are imperative for

adequate social protection, and are often also vital for building public support for

reform. In the case of subsidy reform, for example, it is crucial that those who are

hardest hit by the removal of subsidies be compensated from the beginning through

more targeted social protection. When feasible, bundling reforms as a package of

measures that remove distortions while spreading beneﬁ ts and adjustment costs

broadly can also be useful: it can create more winners, allow the losers by certain

measures to be beneﬁ ciaries by others, and defuse the sense that a particular group is

being singled out.

Figure 6.1.1. Building Coalitions

Low Inﬂuence

OpposingSupporng

EMPOWER

COALESCE COMPENSATE/

DIFFUSE

COMPENSATE

(VULNERABLE)

High Inﬂuence

TOWARD NEW HORIZONS

Sequencing must include initiatives that create visible immediate beneﬁ ts. In

ACTs, it is clear that a strong economic rationale drives political support for

the transitions, which are expected to improve economic opportunities for the

majority of the population. The sustainability of any reform—and support

for the whole reform process—could be jeopardized by the lack of early

and visible economic improvements. To counter this risk, show commitment

to reform, and improve conﬁ dence, policymakers should include in their

reform programs initiatives that will have a rapid impact ( Chapter 5 ), and

consider compensating in advance those vulnerable groups that stand to lose

from the reforms. Policymakers will need to focus on building mechanisms

for such compensation where none are readily available.

Reform champions, together with well-functioning and credible institutions,

are needed to sustain change. Reform-minded individuals are indispensable

for the reform effort, but without strong institutions policies cannot be

implemented; or they can be quickly reversed. For example, in the case

of energy subsidies, successful and durable reforms typically require the

introduction of a depoliticized and rules-based mechanism for setting energy

prices, which can help reduce the chances of reversal. Similarly, strong

institutions, such as an independent central bank and a well-functioning,

well-supervised banking system, are essential for a successful transition from

a managed exchange rate regime to a more ﬂ exible one. However, these

considerations should not prevent policymakers from implementing the

technical measures that are often less contentious but critical in laying the

ground for the success of reforms. In addition, increasing the organizational

resources of groups that owe their wealth not to privileges, spoils, or rents but

to independent activity in a competitive setting, will also increase the political

weight of pro-reform constituencies. Without institutionalized groups

capable of making broadly credible commitments and delivering on them, the

only policies that citizens can directly connect to government performance are

the subsidies and transfers that became a mainstay of the old social contract

(Amin and others, 2012).

As governments embark on economic transformation, the role of

communications will be critical. Governments now need to operate in a multi-

stakeholder environment, where civil society has become more empowered,

and where the unprecedented diffusion of social media ( Table 6.1 ) adds to

both challenges and opportunities. Young people in the ACTs, who were to a

large extent marginalized before the Arab Spring, have formed interest groups

and are voicing their views and demands. Governments also face business

interests and organized labor, which have shown a willingness to protest if

their economic and political demands are not met. In this setting, it will be

important to devote adequate attention to engaging with these groups through

appropriate consultation and communication.

Managing Economic Change During The Transitions

Effective communication needs to be an integral part of the economic

reform process. Public communication campaigns should aim at increasing

awareness of the planned policy changes, explaining the rationale and

building buy-in for the proposed reforms, highlighting their beneﬁ ts

for society at large and for speciﬁ c groups, and establishing realistic

expectations about what can be achieved. Given the emergence of

social media and the connectivity across media networks, it is ever more

important for governments to embark on effective communications

to make a case for reform. For example, when reforming subsidies,

policymakers should explain how expensive and inefﬁ cient existing

subsidies are and the costs they impose on the economy and the

environment. In any reform involving revenue increases or expenditure

cuts, it is important to demonstrate that savings are being used to good

effect. In addition, the communication strategy should also clarify the role

of international ﬁ nancial institutions and the international community at

large in supporting the reform process.

A number of lessons from policymakers’ experiences in other regions can

help increase the chances for successful reform. Policymakers need to explain

what they do, and choose their media strategically for different messages and

audiences. Given the connectivity across media networks, it is even more

important for government ofﬁ cials to speak with one voice, coordinating with

others to make sure that their messages are aligned and mutually reinforcing.

Inspiring messages that are personal and practical tend to be most effective.

Communication efforts should include examples of successful reforms in

other countries, and how obstacles were overcome. To stimulate demand

for reform, it can also be helpful to focus on the missed opportunities

Table 6.1 . Strong Use of Social Networks for Political and Community Views

(Use of social networking in the ACTs; percent)

Use of social networks

Use social networks to express

views about

Politics Community issues

Tunisia 34 67 82

Egypt 30 63 74

Jordan 29 60 80

Global

34 34 46

Source: Pew Research Center, 2013 .

Percent of respondents from a survey among 1000 people in each country.

Percent of social network users who use networks to express views about politics/

community issues.

Median of 21 advanced and emerging economies.

TOWARD NEW HORIZONS

from lack of reform—that is, the costs of doing nothing. At the same

time, communications efforts should not be about “selling” reforms: true

engagement often calls for modiﬁ cation of reform proposals, while keeping

the main goal in view.

Support from the international community

Stepped-up support from the international community is critical for

successful reform. Even as countries need to stay in the driver’s seat and plan

their policy programs through wide national consultation, there is a need for

the international community to support the ACTs’ reform efforts along four

dimensions.

• Bilateral and multilateral partners will need to continue providing

signiﬁ cant ﬁ nancing, increasing its scale in some cases, so that public

spending can support growth and ease the pace of adjustment (Box 6.2).

The signiﬁ cant support from donors in GCC countries to some ACTs,

in particular, has helped cushion the immediate adjustment needs at

a time of reduced trade and capital ﬂ ows. Greater predictability and

stronger coordination of donor efforts with the ACTs’ macroeconomic

plans could further enhance the effectiveness of donor support.

• Improved access for the ACTs’ exports to advanced economies’ markets

is also important to support the economic recovery and raise potential

growth, complementing their efforts at trade reform.

• The ACTs can also proﬁ t from policy advice from their international

partners in many areas of economic policy.

• The international community can help in capacity-building efforts by

providing technical assistance and training.

Donors also have a critical role to play in helping to overcome obstacles

to reform. Close coordination among donors should ensure that they do

not inadvertently provide disincentives for change by supporting divergent

policies. Initiatives such as the Deauville Partnership can play an important

role in this context. Donors should also avoid overburdening the few

agents of change and instead should support them with technical assistance

that is aligned with their needs and delivered on time. For example, it is

important to act promptly to develop the registries required for cash transfer

mechanisms; delays could jeopardize safety net reform. Donors should also

recognize the potential challenges they face in the region stemming from

the stigma attached to previous stabilization measures and structural reform

programs.

Managing Economic Change During The Transitions

Box 6.2 . Continuing Need for Stepped-Up Donor Support

Since the onset of the transitions in 2011, the ACTs have received signiﬁ cant

ﬁ nancial support from the international community, more than half from the GCC

countries (Figure 6.2.1). Their external ﬁ nancing needs will remain high under

baseline projections in 2014–15, at around $50–60 billion per year. Yet, even with

sufﬁ cient external support to cover these needs, the baseline projection of economic

growth will not be sufﬁ cient to tackle the ACTs’ main economic challenge of high

unemployment.

Short-term growth and employment could be boosted by a carefully designed

job-creating public investment initiative, but would require additional external support

(US$24 billion over the next ﬁ ve years in the example of Figure 2.5). This additional

ﬁ nancing would need to be on sufﬁ ciently concessional terms to preserve debt

sustainability, especially in those countries with high debt, and consistent with the

countries’ absorptive capacity. Therefore it is critical for the international community to

do more in mobilizing ﬁ nancial support for the ACTs.

Over the medium term, ﬁ nancing needs are expected to remain substantial but with

private ﬁ nancing–both FDI and private capital markets–playing a bigger role. These

expectations are predicated not only on externally ﬁ nanced public investment initiatives

but also, importantly, on the successful implementation of a comprehensive package

of structural reforms aimed at ensuring sufﬁ cient job creation by the private sector to

maintain employment in the medium term.

G8,

3.6, 7%

GCC, 26.4,

52%

Other IFIs,

9.2, 18%

IMF, 1.3,

Other,

10.8, 21%

Total:

$51.3 billion

Figure 6.2.1 . External Offical Financing for ACTs

(2011–13, USD billions, percent)

Source: National authorities and IMF staff estimates.

TOWARD NEW HORIZONS

The IMF remains closely engaged with the ACTs. IMF staff are engaging with

country authorities and their international partners in the areas of economic

policies and ﬁ nancing. The IMF’s advice to the ACTs has been adapting to

changing external and domestic economic conditions ( Box 6.3 ). Since the

onset of the political transitions, its focus has been on striking the right

balance between measures needed to maintain macroeconomic stability and

protect the poor during the transition, on the one hand, and those laying the

groundwork for faster growth and job creation, on the other. In this context,

the IMF has advised countries to adjust large ﬁ scal deﬁ cits gradually so as to

put ﬁ scal balances on a sustainable path while limiting the adverse short-term

effects on growth and unemployment under the presently difﬁ cult socio-

political conditions. The IMF has committed about $10 billion in ﬁ nancial

arrangements with Jordan, Morocco, Tunisia, and Yemen. IMF staff are in

advanced discussions with Yemen toward a successor arrangement to the IMF

support provided in 2012, are supporting Libya through policy dialogue and

capacity-building efforts, and are ready to engage with Egypt on a possible

ﬁ nancial arrangement when requested. The IMF is active in all ACTs on

policy advice and capacity building, and, in coordination with ACT

governments, has increased its communications with stakeholders, including

civil society organizations, academics, and parliamentarians.

Box 6.3 . Lessons from the Arab Transitions for the IMF

While IMF advice prior to the onset of the transitions in 2011 centered on sound

macroeconomic policies for stability and growth, insufﬁ cient attention was paid

to growing socioeconomic imbalances. Efforts centered on helping countries build

sound macroeconomic foundations, liberalize economic activity, and introduce

market-based reforms that would generate higher economic growth. In addition to

advice on sound ﬁ scal and monetary policies, the IMF recommended strengthening

monetary policy instruments, enhancing the liquidity of government bond markets,

strengthening the soundness and competition of the banking sector, maintaining the

momentum of privatization, improving public ﬁ nance management, lowering the

cost of doing business, enhancing labor market ﬂ exibility, and increasing regional

cooperation and trade liberalization. While the focus was mainly on strengthening

macroeconomic stability and medium-term growth, with hindsight it has become clear

that not enough emphasis was placed on the need to ensure equal access to economic

and employment opportunities.

IMF advice since 2011 has adapted to the challenges of the transitions. Following

the onset of political transitions in 2011, and in light of challenging socio-political

conditions, high public debt, and large ﬁ scal and external imbalances, IMF advice

has focused primarily on bolstering macro stability while strengthening the focus

Managing Economic Change During The Transitions

on employment generation and measures to boost inclusive growth. The IMF has

particularly recommended that ﬁ scal consolidation be pursued at a gradual pace to put

ﬁ scal balances on a sustainable path while limiting the adverse short-term effects on

growth and unemployment. In ACT program countries ( Jordan, Morocco, Tunisia,

Yemen), external shocks have been partially accommodated by loosening the targeted

ﬁ scal deﬁ cits. The IMF has put emphasis on subsidy reform, recommending that

generalized subsidies should gradually be replaced by more cost-effective ways of

social protection. The IMF has also recommended an accommodative monetary policy

stance, in light of subdued inﬂ ation and weak recovery in the region.

The IMF has increased its focus on inclusive growth and political economy.

Realizing that the popular uprisings in the ACTs were born in part of a desire for

more widespread and fairer distribution of economic opportunities, the IMF has

increasingly focused on issues pertaining to inclusive growth. In particular, the IMF has

recommended important economic reforms to reduce high structural unemployment

and deliver a more equitable distribution of income, including enhancing business

and investment conditions, increasing trade openness, improving the stability and

access of the ﬁ nancial system, and improving social safety nets. It has also developed

an analytical tool to better understand the linkages between growth and employment.

Recognizing that countries are operating under difﬁ cult socio-political conditions, the

IMF has increased its focus on the political economy aspects of reform, strengthening

the emphasis on national dialogue and ownership of economic programs and

improved communication of policy intentions.

The way ahead

The political transitions present a historic opportunity to set in motion

needed economic transformations. The transitions have created a

unique opportunity to challenge the status quo and the vested interests that

have supported it in the past. This is the hub of the virtuous circle where

economic transformation and political transition mutually reinforce one

another to deliver on the aspirations of the ACTs. The ACTs have strong

underlying potential for a dynamic economy, including a young workforce,

increasing access to technology, a unique geographic location linking several

continents, and rich tourist destinations. The right combination of policies,

enacted with a clear view of the political economy and with the support of

the international community, can help realize this potential and deliver on the

aspirations of the people of the ACTs.

Box 6.3 (concluded)

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Toward New Horizons:

Arab Economic Transformation Amid Political Transitions