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Impact of the Global Economic Crisis on the Arab Region

By Imed Drine

Whilst having a global impact, the current financial and economic crisis is clearly affecting certain regions more severely than others. One region which may be amongst the worst affected is the Arab region. For some this might be surprising, given perceptions that either the region is wealthy due to its oil riches, or that countries have plenty of foreign exchange reserves to tide them over, or that the region’s banking system is not as exposed to adverse changes in the global financial system. In this article I argue that these perceptions may obscure the fact that the Arab region may be one of the worst affected regions worldwide. It is a diverse region containing both very rich and very poor countries, with a very high dependency on international markets. The region is also facing significant demographic pressures and lacks effective regional integration and well-functioning social safety nets.

I will first give a short overview of the region, and then ask what impact the global economic crisis is having on financial markets, trade and tourism, remittances and FDI.

The Arab Region

The Arab region, consisting of Algeria, Bahrain, the Comoros, Egypt, Djibouti, Iraq, Jordan, Kuwait, Lebanon, Libya, Mauritania, Morocco, Oman, Palestine, Qatar, Saudi Arabia, Somalia, Sudan, Syria, Tunisia, United Arab Emirates (UAE) and Yemen, is a diverse group of countries.

The general perception is that the Arab region is wealthy. The reality, however, is that about 40-50 per cent of people live on less than two dollars a day. The unemployment rate in the region is around 12 per cent as can be seen from Table 1 - amongst the highest in the world. A huge concern is that amongst the young (age 15 – 24) unemployment exceeds 40 per cent.

Table 1: Main characteristics of the region (2000-07)

Source : WDI 2008

Table 1 also shows that, compared to other developing regions, the Arab world is more dependent on remittances (almost 7 per cent of GDP), more dependent on international tourism (14 per cent of GDP) more dependent of fuel exports (56 per cent of GDP). It also shows that the Arab region is more dependent on food imports. Arab countries generally import more than 50 per cent of their agricultural products; the agricultural trade balance recorded a deficit of US$ 25 billion and a food deficit of US$18 billion in 2006.

The Arab region can be divided into three main groups of countries. The first is the oil producing countries (Saudi Arabia, Kuwait, UAE, Qatar, Oman, Bahrain, Libya, and Algeria). As can be seen from Table 2, this group has the highest level of GDP per capita and the lowest unemployment rate; with a high level of exchange reserves, these countries are in a better position to face the crisis.

For these countries oil contributes 36 per cent of total value added, 85 per cent of export revenues and 71 per cent of government fiscal receipts, indicating that these economies still overwhelmingly dependent on petroleum. While the value added of the petroleum industry represents 36 per cent of the region’s aggregate GDP, its contribution to employment, including all petroleum-related activities, is less than 5 per cent. Thus, for these countries, the economic implications of the crisis may not be considerable, as they have accumulated high reserves during periods of oil price increases (an increase of about 50 per cent  in 2006-07).

Table 2: Profile of the Arab Region per Group (2000-07)

Source: WDI, 2008

The second group is states that have more diversified but relatively vulnerable economies (Egypt, Jordan, Lebanon, Morocco, Syria, and Tunisia). Indeed, these countries are deeply integrated into the global economy and dependent on imports both for consumption and investment. Furthermore, exportation, foreign direct investment, remittances and tourism play a key role in economic growth and job creation in these nations. This group of countries, already facing high unemployment and external deficit, does not have sufficient domestic demand to mitigate the fall in external demand, because of low national purchasing power (GDP per head). Moreover, due to a lack of resources, governments cannot launch major investment projects. The relative fragility of the banking industry which depends strongly on the central bank may have an additional dampening effect on the crisis.

The third group includes the poor countries (Sudan, Yemen, Mauritania, Djibouti, Somalia, and Comoros). This group, already suffering from serious economic and social problems, has been abandoned to confront the crisis on its own with little international support. Poverty and social tensions are likely to worsen further. Because of the inability of existing structures to guarantee the minimum of coordination to deal with global downturn, these countries need to fend for themselves in order to overcome the crisis and manage its consequences.

Not only is the Arab region diverse, as Table 2 indicates, but the diversity is accompanied by a relative lack of regional integration. Indeed, despite the favorable conditions achieved by a number of countries and the comparative advantage of geographic proximity compared to other countries, bilateral trade is still very low. Indeed, inter-Arab trade is less than 17 per cent (12.7 per cent of exports or the equivalent of US$65 billion, imports 20.6 per cent, or US$ 62 billion). Therefore, poor regional integration and a lack of effective mechanisms of coordination and cooperation suggest that a regional strategy to deal with the global crisis will not be easy to find.

Financial consequences of the crisis

The initial impact of the financial crisis varied considerably amongst Arab countries. The Gulf States (first group) are the most adversely affected by the crisis if we consider the major loss of overseas investments, especially in the United States and Europe (about 55 per cent of Gulf investments are in the United States). This manifests itself chiefly as a sharp decline in the region’s stock markets (between 20 and 60 per cent), and the cancellation of major projects. The effects are noticeable from the beginning of the crisis in countries with close links to financial market (like United Arab Emirates). The stock market indices have recorded a drop of 30-60 per cent in the last quarter of 2008 and Arab investors lost US$600 billion in direct stock market declines.

The crisis has induced a devastating shortage of capital in the regional banking sector. For example, Kuwait’s Gulf Bank lost US$1.54 billion in 2008. The governments in the Gulf have been forced to pump money into the banks to salvage them. The Qatari government has offered a US$5.3 billion investment package to the banking sector and Abu Dhabi’s Central Bank has intervened with US$32.7 billion to ensure the liquidity of UAE banks.

Before the crisis the size of overseas government investment by the Gulf countries was assessed at about US$1.8 trillion, with approximately 60 per cent held in dollars. According to many analysts, the sovereign funds of the Gulf Arab states could be exposed to losses reaching as much as 40 per cent, particularly with respect to funds maintained in the perceived stable American banking system.

The crisis has affected indirect financing, whether funded by local banks - which have become more reluctant to lend - or by foreign banks, with limited lines of credit. The real estate market has also been hit, which has led to a lack of liquidity and a slowdown in real estate development in places like Abu Dhabi and Dubai.

The financial crisis quickly triggered a real decline in the demand for goods and bank credit contraction. Raw material prices have fallen dramatically, especially oil prices which have lost more than two-thirds of their values within a few months. Indeed, as a result of speculation on oil prices, rates decreased in the last three months of the year 2008 to less than 40 dollars a barrel, after having risen from 90 dollars to 148 dollars a barrel at the beginning of the year.

According to Colliers International Report 2009, the global economic crisis has impacted heavily on the Gulf real estate market, causing considerable decline in real estate capital values and rents. In Dubai, average residential sales prices fell by 42 per cent since the last quarter of 2008, while residential rental rates dropped 20-40 per cent on average. In Abu Dhabi, the impact of the crisis was less acute, as the decline in residential real estate value was around 20 per cent  In Qatar, rentals for newly constructed office space decreased by 10-15 per cent during the first quarter of 2008. Residential real estate sales have collapsed due to lack of funding and greater uncertainty over the future.

Therefore, it will be difficult for many countries in the region to continue with ambitious development projects that were initiated or planned in the last five years of prosperity. In order to avoid budget or current account deficits, most governments in the region will be reluctant to expand projects leading to a contraction of economic activity.

Impact on Trade and Tourism

The direct effect of the global slump on the economic activity of developed countries and the diminishing household purchasing power resulting from rising unemployment as well as added uncertainty about the future, could significantly a reduced demand for exports and tourism in the region.

It is clear that the financial crisis and associated recession in the major capital markets will be reflected primarily in the decline in exports from Arab countries. The critical position of the Arab countries is explained by its broad exposure to foreign markets. The level of openness of the Arab countries to the world economy (measured by the ratio of foreign trade to Arab GDP, according to data in 2006) is about 80 per cent. The contribution of the export sector to regional GDP for 2007 is around 30 per cent, while the tourism sector contributes 15 per cent. Tourism is responsible for 450,000 jobs in Tunisia, 1.5 million in Morocco, 3 million in Egypt, 420,000 in Jordan and 900,000 in Syria.

The problem is amplified by the fact that Arab economies depend on primary goods for exports and food and manufactured goods for imports. Indeed, the share of fuel exports in total exports is about 75 per cent for the Arab region and for some of the Arab countries more than 90 per cent of total exports. In addition, the European and American markets represent about 35 per cent of Arab exports and 47 per cent of total Arab imports. For some Arab countries like Morocco and Tunisia, the contribution of European trade to total trade is more than 70 per cent.

The expectations of declining investment and expenditure in the new powerful economies such as China, India, Brazil and Russia have induced a decline in demand for steel and construction materials, which created a sudden surplus in supply, after a long period of scarcity. Therefore, the slowdown in the international economy will necessarily result in a decrease in economic activity and an increase in unemployment in the Arab region, especially since the lack of international liquidity limits recourse to external finance.

In the service sector, a significant decrease has occurred in demand for international travel and tourism, as well as transport services in general, causing stagnation in the markets and cancellation of orders for new ships and aircraft. It is expected that regional tourism will decline significantly, affecting particularly Tunisia, Lebanon, Egypt and Morocco. Some Arab airlines operating global routes will also be affected, such as Emirates and Qatar airlines. It is expected that Egypt will lose a significant part of the proceeds of traffic through the Suez Canal.

Impact on Remittances and FDI

There will be a decline in remittances from Egyptians, Yemenis, Palestinians and Jordanians, who constitute the lion's share of workers in the Gulf Cooperation Council states and in Libya. The same will apply to Tunisia, Algeria and Morocco, which send workers to EU states, especially France and Spain.

If we take into account the fact that remittances account on average for 6 per cent of the GDP of the countries sending labor, the reduction in remittances could cause a decline in the economic growth rate of such countries. The effects of a decline in remittances will be amplified by the multiplier effect of remittances which normally contribute to support private consumption and domestic investment.

The World Bank report shows that the most important Arab countries receiving remittances in 2007 are: Egypt (US$5.9 billion), Morocco (US$5.7 billion or of 9.5 per cent of GDP), Lebanon (US$5.5 billion or of 22.8 per cent of GDP ), Jordan (US$2.9 billion or of 20.3 per cent of GDP), Algeria (US$2.9 billion or of 9.5 per cent of GDP), Tunisia (US$1.7 billion or of 5 per cent of GDP), Yemen (US$1.3 billion or of 5 per cent of GDP), Syria (US$0.8 billion or of 2.3 per cent of GDP), and the West Bank and Gaza Strip (US$0.6 billion) annually. These are in addition to informal transfers and transfers in the form of vehicles, machines, tools, household items, clothing, and electronics. Such transfers are more important than the foreign aid or direct investments received by these countries, particularly in the Maghreb, Egypt, Sudan, Jordan, and Lebanon. As such transfers have a significant impact on macroeconomic performance in these countries it seems that their decline will have a powerful negative effect.

It is expected that demand for immigrant labor will slowdown as a result of the decline in the economic activity in the countries of employment, particularly in the construction and building sectors. According to some pessimistic estimates, foreign labor to the Gulf Arab states will decrease by 30 per cent in 2009. In general, it expected that remittances will decrease in the medium term especially if the crisis continues for more than one year.

Recent years have seen a marked improvement in the investment climate in many Arab countries and as a consequence investment flows to some Arab countries have increased. Indeed, between 2005 and 2006, the increase in FDI was nearly threefold in Tunisia and more than 50 per cent in Libya, Saudi Arabia, Sudan and Egypt. In general, the Arab region received about 5 per cent of global direct investment flows in 2007. The ratio of FDI to gross capital formation has exceeded 30 per cent in the UAE and Saudi Arabia, despite the fact that the two countries are net capital exporters; by contrast, that proportion had risen to nearly 98 per cent in Jordan and Bahrain, to nearly 50 per cent each from Egypt, Libya, Tunisia, and 6.6 per cent in Algeria.

Expansion over the last year has in general been driven by exports and powered by foreign direct investment. FDI provided capital to cover the gap between domestic savings and development needs in the recipient countries, thus contributing to the creation of new jobs. FDI is not just the means for opening new markets for multinational companies, but to achieve higher productivity through technology transfer. In return, Arab countries offered a young, educated, low cost workforce. In addition, the states guarantee a low corporate tax rate and modern infrastructure. As low cost is one of the most important pillars of country appeal, increased inflation and higher labor costs will be a big concern for the Arab region. Indeed, the fact that they do not have the flexibility to use the fiscal instrument to lift the economy, the use of monetary policy may make these countries too expensive and may dampen the attractiveness of the Arab region to foreign investment.

Concluding Remarks

The global economic crisis will clearly have profoundly negative impact on the Arab region, especially the non-exporting oil countries. A substantial concern is the impact on unemployment, with the Arab Labor Organization expecting the number of unemployed to increase by at least 3.6 million during the biennium 2009 – 2010. Mitigating the impact of this and facilitating recovery in the Arab region would require at a minimum: a recognition of these impacts and their differential impacts across the three groups of countries; and addressing the region’s lack of effective regional integration, excessive dependence on external demand, and absence of well-functioning social safety nets.

WIDER Angle newsletter, June 2009
ISSN 1238-9544