April 24, 2013
Tunisia: Turning Around Finally
By Mohsin Khan and Svetlana Milbert
The announcement on April 19 by Managing Director Christine Lagarde of the International Monetary Fund (IMF), that the Tunisian government and the IMF had reached agreement on a two-year Stand-By Arrangement (SBA) amounting to $1.78 billion could well prove to be a watershed in Tunisia’s economic recovery. What the announcement means precisely is that the agreement with the Tunisian government has been endorsed by the IMF management and thus can be taken to the IMF’s executive board for approval in May.
Earlier in February the Tunisian government and IMF staff had agreed on a Precautionary SBA, whereby the country could draw on the IMF credit if it faced exogenous shocks that required financing. The Lagarde announcement changes the form of the arrangement and now Tunisia will be able to receive the $1.78 billion loan in tranches provided it meets the conditions set out in the agreement. Aside from the financing, the IMF agreement sends an important signal to the markets and other donors that Tunisia has a macroeconomic program that has the support of the IMF.
Prior to the overthrow of President Zine El-Abidine Ben Ali in January 2011, Tunisia had been on a trajectory to join the ranks of the lower income European countries, with economic growth averaging 4.5 percent per year over the decade 2000-10. Then came the Arab uprising in January and the dramatic political changes it generated hit the Tunisian economy hard. The economy went into a serious recession with real GDP falling by nearly 2 percent in 2011. Because of political instability and a deteriorating security situation both tourism and foreign direct investment declined sharply. At the same time, remittances from workers fell off due to the European crisis and the return of Tunisian workers from Libya which was undergoing its own political upheaval.
As a result of these developments in 2011 all major macroeconomic indicators worsened. The unemployment rate rose to 19 percent, with youth unemployment reaching 42 percent. The overall employment rate was significantly higher than the prerevolution average level of 13 percent. The external balances weakened with the current account deficit widening from 4.8 percent of GDP in 2010 to 7.4 percent, and international reserves fell by $2 billion to $7.5 billion. The government adopted expansionary fiscal policies to meet the demands of the population and increased wages and food and energy subsidies. This resulted in a jump in the fiscal deficit to 3.5 percent of GDP compared to 1.1 percent in 2010.
In 2012, the economy showed some signs of recovery as the political situation settled down and the fiscal stimulus worked its way through. Real GDP grew by 3.6 percent and unemployment fell to 17 percent. The external position stabilized with the current account deficit rising slowly to 8.0 percent of GDP and the loss of international reserves was contained. The markets, however, remained nervous about Tunisia’s prospects. The country’s sovereign credit default swaps (CDS) reached over 100 basis points relative to Morocco, its immediate comparator, throughout 2012.
Obviously unsatisfied with these developments and needing a seal of approval for its economic program, the Tunisian government in early 2013 asked the IMF to open discussions on a Precautionary SBA. These discussions proceeded well and the IMF staff announced in February in Tunis that there was broad agreement on the overall parameters of the program. The next step would be to seek the approval of IMF management and then present the program to the IMF executive board in March.
Unfortunately, the timetable was blown off course with the February 6 assassination of Chokri Belaid, a well-known critic of the ruling Ennahda Islamist party. Following the assassination, Prime Minister Hamadi Jebali resigned on February 19 and Interior Minister Ali Laarayedh was appointed as prime minister on February 22. A new government was formed on March 8 with Ennahda acquiescing to the demands of the opposition and giving up control of the “sovereign” ministries of justice, interior, and foreign affairs.
With the new government in place, even though there was no change in the Ministry of Finance, where Elyess Fakhfakh was retained, and in the Central Bank, the IMF delayed the Precautionary SBA. In the meantime, the Tunisian government decided to convert the precautionary arrangement into a standard SBA so that it could receive the financial resources the IMF was ready to provide if the country needed them. The Tunisian government made the request for the change at the IMF spring meetings in Washington in April, and Lagarde agreed to it, leading to the announcement on April 19.
At the very least, this financing would help to partially cover the projected current account deficit of around $3 billion in 2013 and a larger projected deficit of $4 billion in 2014. More importantly, the agreement sends a strong message to the international community that Tunisia had gotten its economic act together. It is now in a position to get past the last two dismal years of economic performance and move back on its path to become a well-managed, middle-income emerging market.
However, despite the success in reaching agreement with the IMF, two important questions remain. First, why did Tunisia opt for a program with financing of $1.78 billion, representing only 400 percent of its quota in the IMF? After all, in 2012 Morocco was able to negotiate a Precautionary SBA amounting to 700 percent of its quota, and Jordan received 800 percent of its quota for its SBA program. Another 200-300 percent of quota would have given Tunisia an extra $1-1.4 billion of IMF financing. This would certainly have helped to meet its projected $7 billion financing gap over the next two years. Furthermore, the IMF loan would be at a much lower interest rate than Tunisia can expect to receive by borrowing in the international markets. Given that the $1.78 billion in IMF financing is now firm, the country will have to look elsewhere to generate funds to fill the financing gap. Tunisia has been able to borrow in the international capital markets through issuance of $400 million in Samurai bonds and $625 billion in a Sukuk issue. Will it be able to go back to the markets, and at what price, to raise the additional financing?
Second, the IMF program and its emphasis on macroeconomic stability, is a necessary condition for achieving a higher growth rate, but it is by no means is a sufficient condition. On the face of it, the IMF program addresses only one of Tunisia’s twin problems of financing and growth. As Lagarde stated, the IMF program is designed to support the Tunisian government’s reform program with its emphasis on creating jobs and reducing income and regional inequalities. The challenge for Tunisia is to generate a growth rate that will lead to job creation so as to absorb the growing young labor force. To do that, a growth rate of 4 percent a year is not enough and Tunisia needs to grow by 7-8 percent.
Financing from the IMF is undoubtedly helpful to Tunisia, but only up to a point. The Tunisian government has its work cut out for it to satisfy the demands in the population which led to the revolution. The government has a priority list of economic reforms which it intends to undertake. These include: fiscal reforms involving cutting subsidies and increasing income taxes and the VAT; financial sector reforms to strengthen the banking system and make it more efficient; investment reforms to reduce regulations and make the country more investor-friendly; and educational system reforms to improve the quality of training and the skills mismatch between the types of graduates which schools and universities produce and the demands of the private sector.
All these various reforms will take time to implement and even longer to show results. In the meantime, the government will be under considerable pressure to create jobs. Obviously these jobs cannot be created overnight in the private sector. Therefore, the only way to reduce unemployment in the short run would be through expanding government employment. The government has already started down this path. The budget for 2013 includes recruiting 23,000 employees in the public sector, and it is likely that this number will increase. While this is not ideal strategy, there does not appear to be any other alternative. Eventually, the public sector has to shrink and the private sector has to expand to achieve Tunisia’s ambitions to become a prosperous emerging market. Politicians have to convince Tunisians to be patient as this is the long-run objective for the country.
Mohsin Khan is a senior fellow at the Atlantic Council's Rafik Hariri Center for the Middle East and Svetlana Milbert is assistant director, both focusing on the economic dimensions of transition in the Middle East and North Africa. Photo credit.