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MENA oil windfalls stifle reform

Despite three consecutive years of buoyant economic growth in the Middle East and North Africa region (MENA), windfalls from higher oil prices have held back reform initiatives in oil producing countries, according to a new report by the World Bank.

Despite three consecutive years of buoyant economic growth in the Middle East and North Africa region (MENA), windfalls from higher oil prices have held back reform initiatives in oil producing countries, according to a new report by the World Bank.

In addition, these same windfalls have negatively impacted the economies of non-oil producing countries, which have been forced to implement short-term adjustments as a result of rising oil prices.

“The sharp rise in oil prices has brought to the spotlight the MENA region’s heavy subsidization of oil prices within the domestic market, a policy officially designed to protect poor households,” reads the report. “Although the resource poor economies are particularly affected, the reliance on oil subsidies pervades the region, with large implications on fiscal positions.”

The Bank points to the impact of high oil prices on Jordan, which imports much of its oil from the Gulf. The resource poor country was particularly impacted by subsidies, due to rapidly rising oil prices and also the loss of oil and gas arrangements with Iraq.

“At the end of 2004, oil subsidies represented 3.1% of GDP, and 11.3% of total current expenditures. A year later, they amounted to 5.8% of GDP and 19% of current expenditures,” notes the report.

In Lebanon, the report pointed out surging Treasury transfers to the public electricity company to cover higher oil costs - resulting in government consumption spending increasing by more than 8% a year over the last two years, compared with spending reductions in previous years.

“Unlike in the past, what is good for the oil producers is not necessarily good for the whole region,” said Jennifer Keller, senior economist and principal author of the report. “Resource poor economies in MENA are facing higher oil import bills and higher oil subsidies. And compared with earlier oil booms, many of the positive transmission channels from the oil economies to the resource poor economies have diminished significantly,” she added.

The 142-page study, titled Financial Markets in a New Age of Oil, examines recent key economic developments in the region, the forces underlying the region’s economic outcomes, and analyses the region’s progress with structural reform.

Aside from highlighting the deteriorating impact of high oil prices on non-oil producers in the region, the Bank does note moves by oil producers to channel windfalls into longer-term assets, and progress with structural reforms that, it says, have been important in determining the direction of the economies in the region.

The Bank commended the region’s oil exporters for having “demonstrated impressive fiscal restraint,” unlike in prior oil booms, and for “building up liquidity through external reserves, oil stabilization funds, and through paying down debt.” It added, “They are also pursing common strategies for the diversification of the oil wealth into foreign assets, as a way to transform the finite oil wealth into longer-term revenue streams.”

However it also cautioned that the oil boom has had “important financial spillovers” for the region. It points out that whilst there has been a positive trickle down effect many of the recent financial sector developments have raised the exposure of MENA economies to negative shocks, and stymied the pace of reform.

“The region’s recent strong liquidity creates a window for the governments of the MENA region to either accelerate or postpone the complicated process of reform, both within the financial sector and in the economy in general,” the Bank said in its report.

“With the large windfall revenues accumulating to oil producers since 2002, a natural question emerges as to what impact oil is having on the reform process,” it continues. “To date, the large budget surpluses appear to have delayed the imperative for reform of the oil subsidy system in resource rich economies. Oil producers have also exhibited weaker reform progress over the last several years than the region’s resource poor economies along two major structural reform fronts: improving the business climate and liberalizing trade.”

According to the report, the MENA region grew by an average of 6.0% in 2005, and by an average of 6.2% a year over the last three years, compared with average growth of only 3.5% over the late 1990s.

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