How the Middle East can prepare for the coming economic storm

Policymakers in the Middle East and North Africa’s emerging markets are confronted with two pressing questions. The first is how to prepare their economies for an even more challenging year ahead, with an increasingly gloomy and uncertain global outlook. The second is asking what policies and reforms can they implement to help mitigate the impact on their populations at a time when their policy space has shrunk to its lowest levels, following multiple shocks, and when economic conditions could take a turn for the worse. Mena emerging markets have shown resilience this year despite the headwinds from Russia’s war in Ukraine. Industrial production is up, employment is rising and the tourism sector is experiencing a revival following the pandemic. Nonetheless, as in other parts of the world, these countries are enduring a strong terms-of-trade shock and high inflation. Inflation is up by almost 50 per cent compared to 2021 levels and is forecast to remain in the double digits through next year. Moreover, the tightening of global financial conditions has already impacted sovereign spreads and countries’ ability to access international markets. However, the deterioration of next year’s outlook and the accumulation of downside risks require strong and timely policy actions. First, commodity prices are expected to stay high and volatile, raising the pressure on central banks to bring inflation under control and governments to tackle heightened food insecurity risks. In some countries, where monetary policy transmission is weak, this may require large increases in policy rates that could risk tipping some into a recession. Second, the era of widely available and affordable external financing is coming to an end and room for policy manoeuvre is narrowing rapidly. About twice as much external public debt falls due each year on average in 2022 and 2023 as in 2019 for the region’s emerging markets. At the same time, significantly tighter global financial conditions are drying up external financing sources for these countries, raising the risk of a funding crunch. Third, what are the prospects for containing debt pressures in the region’s emerging markets when debt in terms of a percentage of GDP at the end of 2021 was already about 10 per cent higher than pre-pandemic levels and when average sovereign bond spreads (excluding Lebanon) were over 600 basis points above levels in the two years before the pandemic? With growth slowing and debt service costs rising, prospects for stabilizing debt are set to worsen. In addition, countries’ ability to provide adequate social protection may also be constrained by higher debt service costs at a time when needs are high. Combined with a yet-unfinished energy subsidy reform in the region, there is no room to increase the current envelope for social spending to address rising social needs, which may strain social cohesion. So how can policymakers prepare for the challenging years ahead and protect their populations? Restoring price stability while protecting the vulnerable is the most urgent policy priority. Monetary policy will need further tightening where inflation is becoming broad-based and expectations are rising. Meanwhile, a tighter fiscal stance that includes targeted support to those in need will contribute to disinflation while strengthening social cohesion. Countries must also act quickly to prevent a food crisis. Harvests next year and beyond could suffer if farmers do not have access to affordable fertilisers. Now is the time to scale up production, secure access to fertilisers for farmers and rebuild food reserves. Looking forward, investing in climate-resilient agriculture will help buffer countries from future climate-related shocks. To maintain debt sustainability and build resilience, policymakers should accelerate inclusive fiscal consolidation, including by completing energy subsidy reforms while building stronger social safety nets and investing in energy efficiency. Doing so will also reduce fiscal pressures while effectively providing support to the vulnerable and easing energy dependency. Authorities would also be well served to make meaningful improvements to the credibility and effectiveness of their policy frameworks. For monetary policy, this means strengthening central bank autonomy and increasing the transparency of monetary operations and foreign-exchange interventions. On the fiscal side, robust medium-term frameworks can bolster confidence, free up fiscal resources and strengthen fiscal sustainability. Greater transparency and accountability can improve efficiency and reduce the fiscal costs and risks associated with state-owned enterprises. With financial stability risks set to rise as shocks continue to batter the region’s emerging markets, policymakers will also need to strengthen their macroprudential policy frameworks to improve financial sector resilience. Finally, accelerating structural reforms has become even more urgent to mitigate potential adverse effects on growth and bolster productivity. Priorities include removing barriers to private firms, enacting reforms that reduce informality and improve tax equity, and investing in climate-resilient technology and infrastructure. The outlook calls for audacious measures, but countries do not need to deal with these challenges alone. The IMF is a partner that stands ready to help. There is no time for complacency. Long-standing reforms are needed now.