A prolonged US-Iran confrontation may spark a new economic crisis in the Middle East

January 10, 2020 5:00 AM
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Mehdi Bolourian/Fars News Agency/WANA (West Asia News Agency) via REUTERS

The threat of all-out war between Iran and the United States may be receding for now. But the prospect of more US sanctions and the underlying economic deterioration of the entire Middle East and North Africa (MENA) region remain a threat to stability and peace inside Iran and among its many unstable neighbors, posing dangers to the global economy.

Civil war continues to grip Libya, Syria, and Yemen, while profound social discontent runs through Algeria, Iran, Iraq, and Lebanon. The deteriorating economic outlook in many advanced and emerging-market economies deepens the threat, but the region is also afflicted by widening income and wealth inequality, high youth unemployment, lack of economic diversification, and climate change.

A protracted conflict between Iran and the United States could have substantial implications for the global economy as well. The spillovers could include higher oil prices, a downturn in global investor confidence, and even a massive new wave of refugees and migrants. The muted response in the oil and financial markets in recent days arguably suggests that the risks to the global economy may not be fully factored in.

The MENA region1 may not be able to withstand a major economic shock, given the weak economic conditions in most MENA countries. Some oil exporters in the region would benefit from higher oil prices, but many do not have much room for maneuvering in terms of economic policies, given their high debt levels and low domestic tolerance for austerity. They need to lower their economic vulnerabilities, and the international community must try to contain geopolitical tensions between the United States and Iran. The international community should also bolster the multilateral frameworks for MENA countries that may need financial and policy support.

A poisonous legacy of the global financial crisis and the Arab Spring

The global financial crisis of 2008 and the Arab Spring and the Syrian refugee crisis, which began in 2011, were big factors in destabilizing the region, along with the decline in global oil prices in 2014. Economic growth in the region declined and social pressures rose sharply in that period. Except for Libya, Syria, and Yemen, where civil war has raged for years, the region as a whole maintained macroeconomic stability and avoided a steep decline in output. This outcome was at the expense of rising debt levels and weaker external financial positions in a number of MENA countries (see figure).

Following the global financial crisis, Arab Spring, and lower oil prices, the MENA region is in a weak position for another crisis

Meanwhile, oil exporters were hurt by lower oil prices and cutbacks in capital inflows. On the other hand, oil importers like Egypt, Lebanon, Morocco, and Tunisia suffered losses in trade, overseas remittances, and finance. Overall, MENA economic growth fell from 5.1 percent in 2007 to 0.8 percent in 2009. But the damage would have been far greater had the region's governments not run large countercyclical fiscal deficits by raising subsidies on energy and food and maintaining the social safety net.

A similar pattern emerged after the political and economic disruptions of the Arab Spring, which led to uprisings in Egypt, Jordan, Libya, Morocco, Syria, Tunisia, and Yemen. Growth in the region dropped, from 4.9 percent in 2010 (before the start of these protests) to 2.4 percent in 2013. But again, through higher spending and financial support from outside the region (especially the Gulf Cooperation Council [GCC] countries), the region maintained overall macroeconomic stability. Of course, the region's conditions deteriorated further after the sharp drop in oil prices in 2014.

These developments could portend a new round of political upheaval and conflict. The region was expected to do a bit better in 2020 compared with 2019 (see table). The International Monetary Fund (IMF) had projected that regional growth would rise to 2.7 percent in 2020, from no growth in 2019. But this outlook is now at risk.


MENA economic outlook projected to improve prior to recent political developments is now at risk
Country Real GDP growth, percent General government fiscal balance, percent of GDP Total government gross debt, percent of GDP Current account balance, percent of GDP Consumer price inflation, percent
  2019 2020 2019 2020 2019 2020 2019 2020 2019 2020
 MENA oil exportersa -1.3 2.1 -3.9 -4.5 32.7 34.2 1.7 0.1 7.0 8.2
Algeria 2.6 2.4 -13.2 -9.9 46.1 49.2 -12.6 -11.9 2.0 4.1
Iran -9.5 0.0 -4.5 -5.1 30.7 28.8 -2.7 -3.4 35.7 31.0
Saudi Arabia 0.2 2.2 -6.1 -6.6 23.2 28.4 4.4 1.5 -1.1 2.2
MENA oil importersb 3.9 4.4 -6.3 -6.4 93.9 94.0 -6.7 -6.4 11.2 9.8
Egypt 5.5 5.9 -7.6 -7.1 84.9 83.8 -3.1 -2.8 11.4 8.4
Jordan 2.2 2.4 -3.4 -3.2 94.6 94.1 -7.0 -6.2 2.0 2.5
Lebanon 0.2 0.9 -9.8 -11.5 155.1 161.8 -26.4 -26.3 3.1 2.6
Tunisia 1.5 2.4 -3.7 -2.8 74.4 78.7 -10.4 -9.4 6.6 5.4
MENAc 0.1 2.7 -4.4 -4.9 44.5 46.6 0.1 -1.3 8.4 8.9
a. MENA oil exporters include Algeria, Bahrain, Iran, Iraq, Kuwait, Libya, Oman, Qatar, Saudi Arabia, the United Arab Emirates, and Yemen.
b. MENA oil importers include Djibouti, Egypt, Jordan, Lebanon, Mauritania, Morocco, Somalia, Sudan, and Tunisia. 
c. MENA includes MENA oil exporters and MENA oil importers.
Source: IMF Regional Economic Outlook: Middle East and Central Asia, October 2019.

Egypt, Jordan, Lebanon, and Tunisia especially have limited room to raise spending or lower taxes to allay domestic discontent, for fear of losing market access and worsening their debt problems. Nearly all these countries have fixed or tightly managed exchange rates, which leaves little space for action on the monetary policy front. Among these countries, Lebanon faces the greatest danger of a debt crisis. It has one of the highest sovereign debt levels in the world and has been compelled to restrict bank and capital withdrawals.

The prospects for financial flows to the region are also not strong. In November 2019, the Institute of International Finance projected that nonresident capital flows to the region would decline in 2020. And that forecast came before the latest crisis with Iran. In addition, capital flows to MENA are twice as sensitive, compared with other emerging-market countries, to risks stemming from global financial market volatility (IMF 2019, chapter 4).

But the global frameworks for official financial assistance may not work as well as in the past. For example, following the Arab Spring, although assistance fell short of the amounts promised, a number of countries and institutions provided considerable assistance to the countries involved.2 The Group of Seven leading economies and the European Commission set up the Deauville Partnership in 2011 to assist "Arab countries in transition" (Egypt, Jordan, Libya, Morocco, Tunisia, and Yemen). The Gulf countries did not set up a formal framework, but they provided the bulk of financial assistance to the region, including through regional institutions. Moreover, the IMF put together programs for Egypt, Iraq, Morocco, Tunisia, and Yemen. And the World Bank opened a new lending window to help the MENA countries affected by the Syria refugee crisis.

But things could be more difficult next time around. Renewed efforts to provide financing and policy advice will be needed in response to a protracted regional conflict. The IMF and other international financial institutions will continue to assist the region, but overall support could easily fall short because the potential donors—including the European Union—are financially weaker and gripped by populist or inward-oriented politics. Rivalries among the big oil producers in the region presage less willingness to help their fellow MENA countries.

Implications

In the final analysis, the rising risks to economic stability in the MENA region portend sobering difficulties for the countries involved and the international community, including increased refugee flows and migration to Europe and beyond. First, the countries in the region, particularly oil importers, should start preparing by addressing their vulnerabilities, for example, by containing the rapid buildup of debt, beefing up social safety nets, and establishing international lines of credit with major central banks, as well as regional central banks. They need to improve debt management, especially in cases where debt restructuring may be the price for help from the IMF.3

Second, most of these countries should move forward with structural reforms like easing business and labor regulations, combating corruption, and reducing waste in government operations. Such steps could take years before they lead to higher economic growth, however. Finally, while something on the scale of a Marshall Plan for MENA is unrealistic, the United Nations and the World Bank can start now to open windows for assisting with refugee issues. Most importantly, all countries should do their utmost to avoid a global economic slowdown, which would devastate one of the most volatile regions in the world.

Note: The author thanks Chris Collins for data analysis and comments.

Notes

1. Here MENA consists of Algeria, Bahrain, Djibouti, Egypt, Iran, Iraq, Jordan, Kuwait, Lebanon, Libya, Mauritania, Morocco, Oman, Qatar, Saudi Arabia, Somalia, Sudan, Syria, Tunisia, United Arab Emirates, and Yemen.

2. Between the start of the Arab Spring in 2011 and 2014, Arab countries in transition received official external disbursements close to $100 billion, but the main share came from the GCC countries (IMF 2015).

3. The recent, difficult experiences of countries such as Argentina and Greece, among others, will likely raise pressures on the Fund to push for preemptive restructurings to ease the economic burden of crisis management.

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