Fiscal Adjustment in Non-oil Producing MENA Countries: Painful but Healthy!

Non-oil producing countries in the Middle East and North Africa (MENA)—particularly Jordan, Egypt, Morocco, and Tunisia—have spent the last decade working hard to achieve fiscal consolidation. The increase in world commodity prices, compounded by the global economic crisis, led to the collapse of the delicate fiscal balance in these countries. Now, fiscal resources are declining just when governments are facing pressure to increase spending. While the four countries are projected to grow in 2009, all are suffering from decreased exports, remittances, and foreign direct investment flows, as well as weakening tourism revenues. Policy makers in these countries can no longer postpone fiscal reforms despite their political costs. Successful policy should rely on both increasing tax revenues and rationing public expenditures. In particular, all four countries need to reform their universal subsidy system and implement a more effective support system for the poor. It is important that governments in each of these countries look beyond the global crisis and make courageous trade-offs to ensure a sustainable future for public finances.

Collapse of the Delicate Fiscal Balance

Non-oil producing countries in the MENA often managed to maintain macroeconomic balance by relying on exceptional budgetary resources like revenues from privatization and/or foreign grants. This delicate balance collapsed in 2007 as world commodity prices soared. The cost of subsidizing energy and food grew to 8.5 percent, 8.2 percent, 5.1 percent, and 4.3 percent of GDP in Egypt, Tunisia, Morocco, and Jordan, respectively. Protecting the purchasing power of their citizens became a pressing concern for all four governments, who felt pressure to increase minimum wages and public sector salaries. The Moroccan authorities increased public sector lower-end wages by 5 percent in July 2008 and another 5 percent in 2009. This is expected to cost the Moroccan treasury 1 percent of its GDP every year. Similar steps were taken in Egypt. 

The effect of the increase in world commodity prices was compounded by the global financial crisis. In 2009, Jordan, Egypt, Morocco, and Tunisia all experienced a sharp decline in exports, tourism revenues, remittances, and foreign direct investments. The decline in economic activity also led to decreased tax revenues. This confluence of economic difficulties puts all four countries in a vulnerable position. Their fiscal resources are declining at time when governments are under pressure to increase public expenditures to sustain investment and consumption levels. At the same time, their current accounts are worsening and foreign reserves are shrinking. Governments in these four countries face the threat of deteriorating levels of public debt ratios and unsustainable fiscal deficits. 

In light of these developments, the fiscal space available for policy maneuvers appears narrow. Fiscal vulnerabilities and limited options for additional resources put pressure on policy makers to postpone non-priorities and choose the most effective projects, but they must also somehow preserve core social spending and meet rising social demands.

Worsening External Accounts 

In spite of predictions of positive GDP growth, all four countries are suffering from the global downturn. The effect of the crisis on exports, tourism revenues, remittances, and foreign direct investment are severely weakening their current accounts and as a result, current account deficits are growing in all four countries. In Jordan, the overall 2008 deficit was barely contained at 6.1 percent of GDP by higher grants, up 75 percent in comparison to 2007. Morocco and Tunisia registered current account deficits for 2008 of 5.2 percent and 4.2 percent, respectively, up from a 0.9 percent surplus and 2.7 percent deficit in 2007. These figures are projected to grow worse by the end of 2009. Egypt managed to keep its current account close to balanced through 2008. However, due to a rapid fall in exports, revenues from the Suez Canal, and tourism, estimates now suggest Egypt will face a 3.2 percent deficit in the next fiscal year. 

Variable Pace of Fiscal Reforms 

The four countries have committed themselves to improving their fiscal balance sheets and reducing the burden of public debt on their respective economies. However, the slow pace of public finance reforms and the severity of external shocks have limited their performance. Overall, the Maghreb countries are progressing faster toward fiscal consolidation.

Morocco has recently reformed its tax system, streamlined and rationalized exemptions, and strengthened tax administration. These measures led to higher tax compliance and significantly improved tax revenues. Strong tax revenue performance, with an average growth rate of more than 20 percent for the period 2005–2008, coupled with a moderate increase in expenditure, improved the overall fiscal deficit between 2003 and 2007. In 2008, Morocco managed to achieve a 1 percent surplus. Similarly, Tunisia improved its fiscal position markedly in 2008 as its deficit fell to 1.2 percent of GDP. Both Morocco and Tunisia reduced their public sector debt, from 58 and 54 percent of GDP in 2006 to 52 and 47 percent in 2008, respectively.

Conversely, Jordan and Egypt are lagging behind. Excluding grants, the budget deficit in Jordan reached 8.5 percent of GDP by the end of 2008. The deficit would have been higher without the government’s bold decision to lift fuel subsidies and introduce price adjustment mechanisms to move world market fluctuations into domestic prices. In Egypt, the government deficit stands at 6.5 percent of GDP for fiscal year 2008–2009.

Challenging Trade-offs 

The governments of Morocco, Tunisia, Egypt, and Jordan face a challenging trade-off between preserving sustainable macroeconomic balances and supporting their economies through public investment and the encouragement of household consumption. They face high and persistent unemployment rates. This is particularly a problem in Tunisia and Jordan, where more than 14 percent of the labor force is unemployed. Lower unemployment statistics in Egypt and Morocco, both under 10 percent, conceal a large number of informal and poorly-paid temporary jobs. Commitment to fiscal consolidation will need to be weighed against social stability considerations. The latter cannot, however, be used as an excuse for excessive and ineffective public spending.

Jordan’s fiscal objective is to keep its deficit manageable while stimulating its economy. Jordanian authorities increased capital spending by 23 percent in 2009, taking advantage of the decline in subsidies driven by lower world food prices and the removal of fuel subsidies introduced in 2008. Nevertheless, Jordan remains dependent on foreign grants to overcome its persistent public deficit. Such grants amounted to 5 percent of the GDP in 2008. The decline of foreign grants in 2009 is likely to unravel the government’s weak structural fiscal position. 

Facing similar public finance challenges, the Egyptian government has less room to maneuver. Public employees’ compensation, consumption subsidies, and other social benefits absorb around 60 percent of total budgetary expenditure. 

In the short term, both Morocco’s and Tunisia’s past fiscal improvements enable them to afford an increase in public expenditure without threatening their macroeconomic stability. However, available fiscal resources need to be directed to investment and to support sectors with high social payoffs. Morocco in particular faces rising pressures from trade and labor unions, exposing policy makers to the risk of misallocating public resources.

Postponing Fiscal Reforms No Longer a Viable Option

Non-oil producing MENA countries are at risk of excessive levels of public debt and unsustainable fiscal and current account deficits. Morocco, Tunisia, Jordan, and Egypt can create room for maneuver by adopting a disciplined approach to managing their public expenditures and taking firm steps toward tax reforms. 

In Morocco, where the share of tax revenues amounts to 26 percent of the GDP—a high number by both regional and international standards—fiscal adjustment needs to focus on the expenditure side. In Tunisia, this ratio stands at 22 percent, 19 percent in Jordan, and only 15 percent in Egypt. Hence, in these three countries, fiscal adjustment should rely on two pillars: increasing tax revenues and rationing public expenditures. 

The first pillar entails broadening the tax base, reinforcing tax administration by improving tax collection capacities, and streamlining exemptions. In Jordan, multiple corporate tax rates (ranging from 15 to 35 percent) create sectoral distortions and inequality among taxpayers. In Egypt, the government needs to pursue value added tax (VAT) reform and secure its expected benefits. Moreover, Egypt should consider increasing the upper bracket income tax of 20 percent, low by international standards, and taxing dividends distributed by Egyptian companies. 

Regarding the second pillar, medium term fiscal sustainability requires that all four countries reform their universal subsidy systems. However, such reform is politically sensitive and the countries may be better off imposing a gradual reduction of subsidies. Jordan took steps in this direction in 2008, when it implemented an automatic mechanism. This reform also served a social purpose, as the poorest 20 percent of the population were receiving 8.9 percent of government subsidies while the richest 20 percent received more than 40 percent of government subsidies. 

Reforming the subsidy system entails a political cost. Such reforms, however, are inevitable. Moreover, these countries do not have the option of postponing action. There is no longer fiscal room to absorb the cost of subsidies, in the face of the oil and food price increases triggered by a global economic recovery. This is probably the best time to make the transition to a more effective support system targeted at the poor. It is important that governments in each of these four countries look beyond the global crisis and make courageous trade-offs to ensure a sustainable future for public finances, despite the short term political costs.