The Covid-19 pandemic has exacerbated the debt crisis for Muslim countries argues Hanaa Hasan, a Research Associate at the Ayaan Institute.

The world economy is fast approaching a global debt crisis warned Nobel Laureate Joseph Stiglitz and UN global economic monitoring chief Hamid Rashid last year. In the wake of the coronavirus pandemic, global debt levels surged to 99% of projected GDP levels in 2020 for the first time on record, as governments were forced to increase spending on emergency healthcare services and relief payments for the unemployed. This has posed many challenges for the Muslim world in particular; most are of middle or low-income status and have struggled to finance their heightened needs as the world economy came to a standstill.

This is particularly true for countries in the Middle East; fiscal deficits widened to 10% of GDP in 2020 up from 3.8% in 2019. Despite signs of an economic rebound, particularly in the Gulf states and Morocco, recovery is likely to be uneven and uncertain. The IMF has warned that financing needs are projected to increase over the next two years, with emerging markets in the region requiring some $1.1 trillion during 2021-22, up from $784bn in 2018-19. By next year, public-debt ratios are predicted to be at their highest levels in 20 years, presenting several long-term economic risks.

National debt in the Middle East

The pandemic only exacerbated a borrowing binge in the  Middle East and North Africa (MENA) region. The six members of the Gulf Co-operation Council issued a record $100bn in public and corporate debt in the first ten months of 2020. The region’s 11 fuel-exporting countries had debts amounting to 25% of GDP from 2000 to 2016 – by the end of this year this is expected to hit 54%. Increases are less dramatic in states without energy resources, but these countries record the highest levels of debt. In tandem, real government revenue fell significantly – by some 24% on average – due to the crisis as lockdowns brought production to a standstill. Thus, increasing costs and falling budgets have witnessed soaring debt levels; Jordan, Morocco, Egypt, Tunisia, and Oman all have national debt that exceeds 75% of GDP.

Coronavirus proved to be the last straw in the case of Lebanon whose descent into economic crisis made headlines last year. Investment since the end of the country’s civil war in 1990 resulted in gleaming property developments in Beirut, but also a successive piling of debt. Interest repayments currently consume almost half of government revenues, crippling public finances and resulting in a political deadlock since 2019. More recently, economic woes in Tunisia prompted the most drastic political change in a decade, with President Kais Saied sacking the government and announcing a crackdown on corruption. Whilst such measures were taken in the name of tackling “wrong economic choices”, his actions have been widely decried as a coup.

Public debt is akin to borrowing from tomorrow and facilitates consumption intertemporally. However, high levels of national debt can severely impact a country’s stability and dampen long term growth prospects. States that rely on domestic banks for government funding needs reduce the availability of finance for small and medium enterprises, limiting their long-term output. Countries with high external debt are also more vulnerable to tightening of global financial conditions, resulting in increased borrowing costs and less access to capital markets. Debt denoted in foreign currency is also problematic; this carries an added exchange rate risk should a country’s currency depreciate, increasing repayments over time.

High levels of national debt are partly endemic to economic development. Low and middle-income nations are forced by virtue of their positioning in the world economy to depend upon richer states to fill the foreign exchange gap and financing needs. A rise in the demand for imported goods requires that foreign exchange be supplied to compensate for natural resource shortages, production inefficiencies, technological backwardness, and low export earnings. However, if structural shortcomings in the economy are not rectified, such dependence on foreign capital becomes a vicious circle of external indebtedness.

For Muslim countries, this often manifests as economic dependence on Western states and an inability to exit the matrix. Even states such as Turkey, which successfully repaid all its IMF debt and became a lender to the IMF in 2013, is still beholden to foreign banks. Owing some $81 billion in foreign currency. Turkey’s indebtedness has worsened with the volatility of the lira in recent years and the recent policy rate rise to 19%. The debt and currency crisis have been a source of popular discontent and present the possibility of a political challenge to the AK Party’s dominance in 2023.

This presents a challenge even to those Middle Eastern states endowed with oil, such as the Gulf monarchies. Whilst in the short run, oil rich countries are more likely to be able to repay their debt, in the long run such states are at greater risk of default. With domestic consumption solely reliant on resource wealth, high levels of spending are hard to constrain when oil prices fall. The unprecedented appearance of negative oil prices in the early months of the Covid crisis last year also highlighted that the security presupposed by ownership of resource wealth does not always materialise.

Military spending is also a large component of Middle Eastern states’ budgets that is significant in contextualising debt levels in the region. On average, military spending makes up 4.56% of GDP, but countries such as Saudi Arabia spend as much as 8.4%. Far greater than the 1.52% average of developed countries, military spending is often justified as necessary due to the high degree of conflict in the region. Yet most of such spending is directed towards the purchase of weapons, which does little to improve the country’s development or the well-being of the population. By contrast, average spending on healthcare in the region falls below other regional averages at just 5.96% of GDP. By contrast, the East Asia and Pacific region spends 6.67%, Europe 10.14% and Latin America 6.6%. In place of urgent spending needs, Middle Eastern states rack up high receipts on heavy weaponry that have little immediate benefit.

Between a rock and a hard place

Unsustainable levels of debt in the Middle East are problematic considering structural economic obstacles in the region. Despite decades of attempts to shrink the state and reduce its presence in the economy, the government is still a major player in the provision of services and employs a significant amount of the population. Financial institutions such as the International Monetary Fund and the World Bank have long seen the presence of the state in the economy as problematic and encouraged programmes of austerity and fiscal consolidation. For example, in Egypt this included the cutting of fuel subsidies by 45% in the first half of the 2020/21 financial year. The government also approved an increase in fuel prices last month as per reform recommendations from the IMF, compounding the impact on consumers.

Ideally in the long run, the private sector is intended to fill this gap. States are consequently advised by international organisations to ease the business environment through the creation of financial incentives and the improving of legal infrastructure to facilitate investment. However, this recommendation is largely not actionable in Muslim countries due to an absence of big businesses, and so foreign investment from multinational corporations is encouraged to fill the void. Yet rather than providing fair and sustainable provision of basic welfare services, private firms instead capture market access for profit-seeking purposes. Far from being a right rooted in citizenship, healthcare programmes and infrastructure projects become products that can be sold to the highest bidder.

Such solutions place Muslim countries in a difficult position; unable to finance their spending themselves, they are forced to borrow or turn to foreign investment. Yet in doing so, they either accumulate greater debt or allow access to foreign corporations that prioritise their own gain above efficient service delivery.

Post-pandemic: More of the same?

While the direct impact of the pandemic is lessening in Western countries and vaccine rollouts reduce the severity of the infection, coronavirus still constitutes a severe threat elsewhere in the world.  Vaccine inequality is also likely to persist in the short to medium term; while richer states such as the UAE and Saudi Arabia were quick to start vaccinating their populations, many such as Tunisia are battling with severe increases in infections. The effects of the pandemic will consequently be felt in the region for a long time to come.

An exclusive focus on fiscal consolidation to reduce national debt at this point would be counterproductive for countries still battling the virus. With many health systems already struggling to cope and the disproportionate impact of the virus on poorer households, fiscal spending is crucial to protecting the most vulnerable.

In the aftermath of the immediate crisis, a strategy for dealing with existing debt must be presented. In the short run, debt restructuring, or debt relief are promoted as potential solutions. Sudan is the latest country to have more than 90% of its external debt – some $50 billion – wiped out as part of the Heavily Indebted Poor Countries Initiative over the next three years. Debt restructuring can provide more fiscal space to countries struggling and is less costly than making such arrangements after default.

However, in the long run, a more holistic perspective is required to understand how state spending can be restructured away from unproductive or wasteful investments and into sustainable service provision. This also necessitates a deeper understanding of the structural issues in Middle Eastern countries and how such obstacles can be overcome, and funds mobilised. Improving governance and transparency is fundamental to this effort, as is recognising the problems posed by globalisation and how Muslim states can work towards greater independence.

By Hanaa Hasan research associate at Ayaan Institute