Two years after the 23-year rule of Zine el-Abidine Ben Ali was brought to an end, the recovery of Tunisia’s economy is not going as smoothly as the government might have hoped. On 12 December, Fitch Ratings, one of three major international ratings agencies, downgraded the country’s sovereign ratings.

“We believe the political transition will last longer than initially expected”

Amelie Roux, Fitch Ratings

Tunisia’s long-term foreign currency was taken down a peg from BBB- to BB+, with a negative outlook and the country ceiling dropped from BBB to BBB-. The agency cited the country’s protracted political transition as the reason for the move.

“We believe the political transition will last longer than initially expected,” says Amelie Roux, director of Fitch Ratings in Paris and the agency’s lead analyst on Tunisia.

“Parliamentary elections have been postponed from March 2013 to June, and they may be postponed again. We believe that 2013 will be another transition year from a political point of view, which may mean that social unrest will continue.”

Political transition

Given the scale of the challenge, the transition from the one-party rule of Ben Ali to a more open and representative political system has so far been relatively smooth.

A three-party governing coalition has been formed, which has a majority in the National Constituent Assembly (NCA), the body elected to draw up a new constitution for the country. The constitution is currently being drafted with the help of a national consultation process, and parliamentary elections are due to follow.

But from an economic perspective, the drawn out nature of the political transition, which has already taken two years, is damaging. “If political uncertainty continues, it will have a strong effect on investment in the economy,” says Raza Agha, chief economist for the Middle East and Africa at investment bank VTB Capital in London.

The impact of the first year of transition on Tunisia’s economy was severe. Despite political turmoil across much of the Middle East and North Africa (Mena) region in 2011, Tunisia’s was the only economy rated by the major agencies to suffer a contraction.

After gross domestic product (GDP) growth of 3 per cent in 2010, and average growth of about 4.5 per cent between 2002 and 2009, the economy shrank 1.8 per cent in 2011. By comparison, Egypt expanded by just under 2 per cent, while Morocco enjoyed almost 5 per cent growth.

Tunisia’s other headline indicators, published by the Washington-based IMF in September, make for equally sombre reading. Increased government spending on wages and subsidies on food and energy imports pushed up the fiscal deficit to almost 3.7 per cent in 2011, from 1.1 per cent in 2010.

A fall in tourism receipts and other inward investment widened the current account deficit to 7.3 per cent, from 4.8 per cent, during the same period. Unemployment rose from 13 per cent to 18.9 per cent. Gross international reserves, in terms of coverage of goods and services, dropped from more than four months to just over three months.

The scale of Tunisia’s downturn was due not only to the disruption of regime change and the government’s expansionary fiscal policy, but also to the economic downturn in Europe. The country’s small, open economy is highly exposed to the fortunes of its neighbours across the Mediterranean.

Europe accounts for about 70 per cent of Tunisia’s foreign tourists, absorbs more than 70 per cent of its exports and is responsible for more than 75 per cent of foreign direct investment and more than 60 per cent of official development assistance, according to VTB Capital. The downturn in Europe will continue to hamper the recovery of the small North African state in the short term.

Positive outlook

Despite its exposure to Europe, the overall health of Tunisia’s economy is not so poor as in other parts of the region, according to economists. “The situation is not as dire as elsewhere,” says Agha. “That is principally a reflection of the fact that Tunisia’s external financing requirements are much lower than most other markets. External debt amortisation, the current account deficit and short-term debt amount to a combined $14.7bn, compared with more than $20bn in Morocco and nearly $30bn in Egypt. Tunisia has also been active in terms of getting donor support. Even though it is more exposed to Europe, there is much more confidence in the market in Tunisia’s economy than there is in that of Egypt.”

The past year has seen a return to economic growth and there are signs of a recovery in the manufacturing and tourism sectors. But the muted level of the rebound, amounting to a 2.8 per cent rise in GDP in 2012, is little more than a correction of the 2011 dip.

According to forecasts from Fitch and the IMF, the recovery will be stronger in the coming year. Both institutions predict growth of 3.5 per cent in 2013. But not all economists share this positive outlook.

“I think the continued uncertainty of the political situation, combined with the impact of the downturn in Europe, makes a 3.5 per cent growth rate highly optimistic,” says Agha. “I’d be happy to see growth of 2 per cent in 2013.”

Reducing deficit

After a widening of the fiscal and current account deficits in 2012, both are expected to narrow in the coming year, according to Fitch. The fiscal deficit grew to 7.2 per cent in 2012 but is expected to fall to 6.6 per cent in 2013, while the current account deficit is expected to narrow from 7.5 per cent to 6.8 per cent.

“We expect the fiscal deficit to narrow because of better growth and efforts by the government to moderate current expenditure,” says Roux. “The current account deficit will fall with an increase in exports to the eurozone. But it will take time to get both deficits under control.”

The more pressing challenge for the government is to rein in its expenditure without incurring a social cost. Reducing government expenditure might help balance the books, but if spending is cut by restricting public investment and removing subsidies on essential items, the impact on the population may be unpalatable.

“Labour relations are an issue across the Mena region because the government is the principal source of investment,” says Agha. “There is pressure to reform the fiscal sector because of the burden of public sector wages and pensions on the treasury. But this means reducing the size of the workforce, which given the social conditions, will be difficult.”

One of the key drivers behind the uprising against Ben Ali in January 2011 was a lack of jobs and a vast disparity in income between rich and poor. So far, little has been done to address either of these problems. “The government has made some efforts to re-distribute wealth to the regions, but this isn’t enough,” says Sami Zemni, head of the Middle East and North Africa research group at the Ghent University Centre for Third World Studies in Belgium.

“It needs to create an entirely new economic structure for parts of the country that have been neglected for decades. It’s the most pressing problem, but there’s no easy solution. It will take years.”

“It’s hard to see the prospects for employment improving in the near term”

Raza Agha, VTB Capital

These challenges are made all the more difficult by the uncertainty of the political situation. The current government is a fragile alliance between three political parties that have little in common, and is in power on only an interim basis. “It’s not easy for a transition government to introduce unpopular reforms, so there can be a tendency not to cut the deficit,” says Roux.

Political uncertainty, social instability and government inaction on the economic policy front are all downside risks to the prospect of a stronger recovery in 2013.

“In such an environment, it is incumbent on the regime to show a great deal of flexibility and accommodation, but this has not been the case,” says Agha. “It’s hard to see the prospects for employment improving in the near term. The political situation has to be stabilised before anything gets done.”

The government’s fiscal problems may be exacerbated by the need to recapitalise the local banking sector.

According to the IMF’s Article IV report on Tunisia published in September, the official rate of non-performing loans at the end of 2011 was 13 per cent of total loans. The way that the figures are reported means that the actual rate is likely to be considerably higher, say economists and provisioning to cover these potential defaults is poor.

Recapitalisation could cost the country 3-7 per cent of GDP, according to the IMF. The process would be carried out over a number of years, but could prove a significant drag on economic growth. “If the banking sector requires a large amount of recapitalisation that could affect our rating,” says Roux.

Dwindling reserves

The precarious foreign reserves position is another downside risk for the economy. The treasury is teetering on the brink of three months of imports cover below which economies are considered to be exposed.

“We remain cautious about the level of international reserves,” says Roux. “At the moment it’s quite low. We expect them to stabilise in the future, but if they fall further it will be a concern.”

The consensus among economists is that the prospects for a genuine turnaround in Tunisia’s economic fortunes are dependent on a speedy return to political stability. “To improve our rating, we would need to see a smooth transition to a newly elected government, and an economic reform programme to gradually reduce the fiscal deficit and the current account deficit,” says Roux.

But for a new government that has come to power during an economic downturn and faces the challenge of placating a population impatient to see the economic fruits of political change, this is easier said than done.