Contents Acknowledgments ix Assumptions and Conventions x Country Groupings xi World Economic Outlook 1 Middle East, North Africa, Afghanistan, and Pakistan 3 MENAP Region Highlights 5 9 Points saillants de la situation dans la région MOANAP 13 1. MENAP Oil-Exporting Countries: Grappling with Lower Oil Prices and Conflicts 17 The New Environment: Lower Oil Prices 17 Fiscal Consolidation and Conflict Weighing on the Economy 18 Diverging Inflation Trends 18 Risks to the Outlook Remain Elevated 19 Lower Oil Prices Call for Further Fiscal Consolidation 22 Financial Sectors Sound, with Pockets of Vulnerabilities Mainly in Non-GCC Countries 26 Wanted: A Diversified Private Sector 27 2. MENAP Oil Importers: Growth Trending Up, but More Reforms Needed to Create Jobs 33 Strengthening Recovery 33 Serious Headwinds Holding Back Faster Recovery 37 Fiscal, Monetary, and Structural Reforms 41 International Support 42 Caucasus and Central Asia 45 CCA Region Highlights 47 Основные положения по региону КЦА 49 3. Caucasus and Central Asia: Reforms Needed to Weather Shocks from Commodity Prices and Russia 53 Economies Hit by External Shocks 53 Risks Tilted to the Downside 54 Exchange Rates under Pressure 54 Fiscal Policy: Supporting Near-Term Growth, Rebuilding Buffers, and Keeping Debt Sustainable 58 Monetary Policy Faces Complex Trade-offs 61 REGIONAL ECONOMIC OUTLOOK: MIDDLE EAST AND CENTRAL ASIA iv External Vulnerabilities Have Risen 61 Spillovers from the Economy to the Financial Sector 62 Improving Medium-Term Prospects and Creating Jobs 62 4. Fiscal Adjustment to Lower Oil Prices in MENA and CCA Oil Exporters 65 Lessons from Previous Oil Price Drops 67 Adjustment Policies at Present 68 Desirable Fiscal Policy Actions 70 Complementarities with Other Policies 75 Conclusions 76 5. Economic Implications of Agreement with the Islamic Republic of Iran 81 The Current State of Iran’s Economy 81 How Will the Lifting of Sanctions Affect the Iranian Economy? 82 The Agreement’s Effect on Global Oil Prices and Economic Activity 84 How Will Iran’s Non-Oil Trade with the Region Be Affected? 85 6. How Might the Sustained Decline in Oil Prices Affect MENA and CCA Banking Systems? 89 How Can Low Oil Prices Affect Banking Systems in MENA and the CCA? 89 How Has Bank Soundness Been Affected So Far? 91 How Vulnerable Are MENA and CCA Banks to Sustained Low Oil Prices? 94 How Can Policies Help Mitigate Financial Stability Risks? 96 7. Spillovers from Russia to the CCA 99 Outlook for Russia and Channels of Spillovers 99 Current and Expected Impact on CCA Countries 101 Policy Responses 101 Boxes 1.1. Growth Impact of Lower Oil Prices in MENA and CCA Countries 19 1.2. Estimating the Economic Costs of Conflicts 21 1.3. How U.S. Monetary Policy Normalization Would Affect the Middle East and Central Asia 23 1.4. Trying Times for Fragile States in MENAP 28 2.1 Policy Implications of the Growing Refugee Crisis 34 2.2. Oil Prices and Remittances from the GCC to the Mashreq, Pakistan, and Yemen 36 2.3. Public Investment as an Engine of Growth 38 3.1. Strengthening Linkages between China and the CCA 55 3.2. Balancing Macroeconomic and Financial Stability Objectives in CCA Countries 59 v CONTENTS 4.1. Fiscal Space in Oil-Exporting Countries 72 4.2. Developing and Deepening Local Currency Debt Markets in the GCC 77 4.3. Fiscal Adjustment in Response to Lower Oil Prices in Oil Importers 78 Figures 1.1 Brent Crude Oil Price 17 1.2 Oil, Non-Oil, and Total GDP Growth 18 1.3 Share of Non-Oil Exports by Destination 22 1.4 Average Growth Correlations with China 22 1.5 Fiscal Balance, 2012–20 25 1.6 Fiscal Buffers and Breakeven Oil Prices, 2015 25 1.7 Change in Non-Oil Primary Balances 26 1.8 Employment Outlook in the GCC 27 1.9 Diversification 28 1.1.1 Impact of Fiscal Consolidation on Real GDP Growth 19 1.2.1 Frequency of Conflict, by Region 21 1.2.2 Average Intensity of Conflict, by Region 21 1.3.1 Correlation of Prime Lending Rates between MENAP and CCA Countries and the United States 24 1.3.2 Financial Market Correlation With Emerging Markets, 2013–15 24 1.3.3 Growth Correlations, 2003–14 24 1.4.1 Real GDP Growth Rates for MENAP Oil Exporters and Importers 29 1.4.2 Gross International Reserves 30 2.1 Breaking Free of Stagnant Growth? 33 2.2 Contributions to Growth: Exports and Investment Join Consumption 35 2.3 Growing Confidence 35 2.4 Subsidy Reforms and Lower Oil Prices Create Space for Growth-Enhancing Spending 37 2.5 Strengthening External Demand 39 2.6 Sharp Drop in Inflation Follows Low Food Prices 39 2.7 Competitiveness Challenged by Appreciating Real Effective Exchange Rates 40 2.8 Striving for Higher Growth 41 2.9 Increased Confidence from Fiscal Consolidation 41 2.10 Cornerstones for a Higher Growth Path 42 2.2.1 Remittances to Mashreq, Pakistan, and Yemen 36 2.2.2 Oil Price, Non-Oil GDP, and Remittance Outflows from the GCC 36 2.3.1 Correlation between Annual Real GDP Growth and Annual Change in Public Investment 38 REGIONAL ECONOMIC OUTLOOK: MIDDLE EAST AND CENTRAL ASIA vi 3.1 CCA Growth Rates 53 3.2 Trade Partner Growth Rates 54 3.3 CCA Exchange Rates 58 3.4 CCA’s Overall Fiscal Balance 60 3.5 Fiscal Breakeven Oil Prices in the CCA 60 3.6 CCA’s Current Account Decomposition 61 3.7 Structural Reforms Needed in the CCA 63 3.1.1 CCA’s Trade with China 55 3.1.2 China’s Linkages with the CCA 56 3.1.3 China’s One Belt One Road Initiative and Future Investment Commitments 57 4.1 Impact of Lower Oil Prices on Fiscal Balances, 2014–15 65 4.2 Projections of Public Debt under Alternative Scenarios 66 4.3 Gap between Projected Fiscal Balances and Desirable Policies 67 4.4 Fiscal Policy Responses during the 1970s and 1980s 68 4.5 Fiscal Policy Responses during the 1990s and 2000s 69 4.6 Dissecting the Deterioration in Fiscal Balances between 2014 and 2015 69 4.7 Change in Spending and Revenue between 2014 and 2020 71 4.8 MENA Oil Exporters: Selected Spending Categories 74 4.9 GCC: Composition of Revenue and Spending 75 4.10 Impact of Exchange Rate Depreciation on Oil Revenues 75 4.1.1 Public Debt Ratios, 1970–2020 72 4.1.2 Sovereign Ratings and Public Debt 73 4.2.1 Domestic Debt Issuance by Nonfinancial Corporations, 2014 77 4.2.2 GCC Government Domestic Debt Stocks, 2015 77 4.3.1 World Oil Price and Retail Fuel Prices 78 4.3.2 Impact of Lower Oil Prices on Fiscal Balances 78 5.1 GDP Level 81 5.2 Non-Oil Sector: Labor Productivity and Components 82 5.3 Oil Sector: Production and Exports 82 5.4 Iran: Projected Real GDP Growth and Contributing Factors Post Sanctions 83 5.5 Estimated Global Impact of Sanctions Removal 85 5.6 Iranian Exports, 2009–14 86 5.7 Nonhydrocarbon Trade 2012–13 and Growth in Trade from 2009–11 to 2012–13 86 6.1 MENA and CCA: Banking System Vulnerabilities 90 6.2 CCA: Recent Developments in Banking System Soundness and Performance 92 6.3 MENA: Recent Developments in Banking System Soundness and Performance 94 6.4 Banks Derive Most of Their Income Domestically 95 7.1 CCA Links with Russia, 2014 (or latest available) 99 CONTENTS vii 7.2 Remittances from Russia 100 7.3 Revisions to Real GDP Growth, 2015 101 7.4 Change in Cyclically Adjusted Fiscal Balances 102 Tables 1.4.1 Country Policy and Institutional Assessment 29 4.1 Recently Announced Fiscal Measures in MENA and CCA Oil-Exporting Countries 70 4.1.1 Alternative Measures of Fiscal Space 73 4.3.1 Subsidy Reform Progress in Selected Countries 79 5.1 Annual Value Added, Employment, and Productivity Growth 82 5.2 Regional Implications of Iran Sanctions Relief for MENAP and CCA Oil Exporters 87 5.3 Regional Implications of Iran Sanctions Relief for MENAP and CCA Oil Importers 88 Statistical Appendix 105 References 115