The Twin Deficit Hypothesis in the MENA Region: Do Geopolitics Matter?

This paper examines the relationship between fiscal and external balances in MENA oil versus non-oil countries in the context of the twin deficits hypothesis (TDH) using Panel Vector Autoregression- Generalized Methods of Moments PVAR GMM estimation, Granger Causality and IRFs. The essence of this analysis is to assess the vulnerability of fiscal and external balances to oil price dynamics and regional geopolitics in the region. Results show that a twin-deficit problem exists in MENA oil-rich countries only while the problem does not exist in non-oil ones. This affirms the hypothesis that oil dependence results in high fiscal vulnerability to geopolitical shocks that automatically transmits to external balances. While a TDH isn’t proven to exist in non-oil countries, fiscal and external balances problems result from longstanding structural factors. A high reliance on tourism revenues and remittances as main sources of foreign currency receipts (together with poor tax administration and enlarged current spending bills) makes those countries more vulnerable to domestic and external shocks; reflected in both growing fiscal and current account deficits. A large imports sector and relatively poor exporting capacity also contribute to weakening external accounts. The main policy recommendations for MENA oil-rich countries rely in the importance of strengthening the non-oil sector in order to diversify domestic sources of revenues. Adopting flexible exchange rates is recommended to decrease the vulnerability of the external shocks to oil price dynamics. For non-oil MENA regions, fiscal consolidation, reforming current spending and strengthening tax administrations are crucial to improve fiscal performance. Export-led growth strategies and inclusive growth policies would also contribute to improving external accounts in the examined economies.

How Does Profit Shifting Affect the Balance of Payments?

Profit shifting by multinational enterprises—through manipulation of transfer prices of related-party trade, intragroup lending, or the location of intangibles—affects international flows, raising the question of its impact on the current account and external balances. This paper approaches this question theoretically and empirically. In theory, profit shifting distorts the components of the current account and bilateral current account balances but leaves a country’s aggregate net balance unaffected. There is, however, a real effect on current account balances, because taxes are paid to different jurisdictions. Moreover—in practice—the measured current account could change, because not all transactions are equally easy to track. Our panel empirical results broadly confirm that the current account balance tends to be, on average, unaffected by profit shifting, but taking heterogeneity into account we find that both the real tax effect and mismeasurement strengthen income balances—and thus the current account—in investment hubs.

Prospects for Turkey in 2021

Significance Fiscal and monetary stimuli and a policy-induced credit boom have combined with the broad normalisation of social life to contain COVID-19's impact on economic output. However, the authorities have been reining in these policies as external balances weaken and the lira crashes.

Jordan

Since the approval of the EFF arrangement the near-term economic outlook has worsened considerably due to the COVID-19 crisis and the strict lockdown measures to contain it. In 2020, output is expected to contract sharply, fiscal and external balances are expected to deteriorate, public debt to increase, and a $1.5 billion balance of payments gap to emerge. With the first EFF review still several months away, and an ad hoc augmentation not being feasible in view of the difficulties in recalibrating the existing program to ensure that it remains on track to meet its objectives, the authorities have requested urgent support under the Fund’s Rapid Financing Facility (RFI). The proposed purchase of SDR 291.55 million, 85 percent of quota or about $400 million would cover about 1/4 of the financing need. The rest is expected to be covered by Jordan’s development partners and by targeting smaller accumulation of reserves than under the EFF arrangement.

Kuwait

This 2020 Article IV Consultation with Kuwait highlights that non-oil growth strengthened to estimated 3 percent in 2019, propelled by government and consumer spending. The challenge to reduce dependence on oil and boost savings has become more urgent. The subdued forecast for oil revenues is weighing on near-term growth and fiscal and external balances. Embedding fiscal measures in a comprehensive reform package that promotes private sector growth, strengthens governance and accountability, and improves public services would help build broad support for reforms. A rules-based fiscal framework would improve management of oil revenues. A rule-based framework would help anchor fiscal policy on a long-term objective of intergenerational equity. It should include a well-calibrated operational rule that helps reconcile long-term savings and near-term economic stabilization objectives. Financial sector reforms should focus on bolstering resilience and deepening inclusion. Sustaining reforms to foster private sector-led and diversified growth will be critical. With limited scope for public employment going forward, a vibrant private sector must emerge to absorb the large number of Kuwaitis entering the labor market in coming years.

Timely Balkan virus precautions may avert the worst

Subject The spread of COVID-19 in the Balkans. Significance In general, EU member states in the Balkans are following the policies and guidelines set in Brussels regarding movement of people, trade and fiscal constraints, adapting them to local conditions. Applicant states are following a similar path in fighting the spread of COVID-19, but some (most vocally, Serbia) have expressed disappointment about losing access to medical supplies from the EU and have turned to China for help. Impacts Failure to show solidarity will make little practical difference to the EU-27 but carry great symbolic significance for applicant states. Healthcare systems will be severely tested, especially in the more fragile EU applicant states where they have been underfunded for decades. The loss of tourism revenue in particular from the Adriatic and Black Sea coasts will affect external balances and the public finances. Carmaker closures have now become widespread in Romania, with Dacia and Ford suspending activity for the time being.