While 2014 has seen a significant political stabilisation in Tunisia, the country’s economy remains weaker than it has been for decades. The violence and stalled negotiations of 2013 scared away both tourists and foreign businesses, weighing on growth, keeping unemployment high and increasing the country’s debt to unsustainable levels.

Strong support from international financial institutions means Tunisia can get through this economic crisis and revive investor confidence. But the recovery depends primarily on successful elections.

If the polls fail to form a stable government, the fallout will delay key decisions on economic reform. This will derail the strict reform schedule demanded by Tunisia’s official creditors as a precondition to financial aid.

Disappointing growth

As things stand, growth has been disappointing and the country’s sizeable budget deficit remains a major cause for concern. Tunisia’s economy expanded by 2.6 per cent in 2013, driven partly by increased government spending due to the large jump in the number of workers employed in the public sector and the country’s hefty subsidy bill, which came up to TD3.6bn ($2.3bn).

The 2013 GDP figures show a slowdown in growth from 2012, when the economy grew by 3.6 per cent, rebounding from the 1.9 per cent contraction it saw in 2011.

Since former president Zine el-Abidine Ben Ali was ousted in 2011, agricultural production and the oil and gas sector have both seen declines, while the manufacturing industry has stagnated. Unemployment has remained high, standing at 15.3 per cent at the end of 2013, well above the pre-revolution level of 13 per cent. Of particular concern is unemployment among young graduates, which was 34 per cent at the end of last year.

This high level of unemployment remains despite an expansion in civil servants’ salaries and recruitment of new workers, which has inflated the public wage bill by 40 per cent since 2010.

The sizeable subsidy bill and ballooning cost of public wages have seen the fiscal deficit expand rapidly since the recent uprising, growing from 1 per cent of GDP in 2010 to 5.9 per cent last year. This pushed public debt to 45.4 per cent of GDP in 2013, from 44.3 per cent the previous year.

Dangerous statistics

The political crisis has also damaged foreign reserves, with Tunisia’s current account deficit growing to 8.4 per cent of GDP in 2013. Foreign exchange reserves fell by more than $1bn in 2013, hitting $6.8bn at the end of the year and dropping to $6.5bn in April 2014 – a level equal to just three months of import cover and described as “dangerous” by central bank governor Chadli Ayari.

Inflation has slowed slightly, but remains problematic, maintaining pressure on Tunisians struggling to make ends meet. Consumer price inflation (CPI) came in at 5.5 per cent in February, down from 6.3 per cent a year earlier.

One of the factors adding inflationary pressure is the weakened state of the Tunisian dinar, which has fallen by more than 10 per cent against the euro in 2013 and only saw a brief recovery early in 2014 on the back of the political recovery.

The deterioration in Tunisia’s public finances has not escaped the attention of the major credit rating companies, which have all slashed the country’s ratings, increasing its borrowing costs. After the 2010 uprising, the US’ Standard & Poor’s (S&P) downgraded Tunisia’s sovereign rating by six notches before discontinuing its Tunisia ratings in December 2013 at the request of the Central Bank of Tunisia and the Tunisian government.

In April, Fitch affirmed its BB- rating for the country, saying that despite the passage of the constitution and new electoral law there was still uncertainty over whether the upcoming elections “can bring about political stability and economic revival”.

Strong donor support

Although growth is slow and the budget deficit is large, significant support from international financial institutions and bilateral creditors means it is possible for Tunisia to avoid default and get its economy back on track. But continuing support from the likes of the Washington-based IMF depends on the government keeping to a strict reform schedule.

Straying from this schedule saw access to cheap credit cut off in the second half of 2013, but in 2014 creditors resumed their multibillion-dollar campaign of financial support.

In April, the IMF handed over the third tranche of its $1.7bn, 24-month Stand-By Arrangement (SBA), which was originally approved on 7 June 2013. On 16 July, it released a statement saying the country was on course to receive another SDR143.3m ($220m) tranche after the conclusion of an ongoing review.

While the fund is targeting macroeconomic issues and Tunisia’s ailing financial sector, Africa Development Bank (ADB), Japan International Cooperation Agency (JICA) and German state-owned development bank KfW are focusing on the private sector, agriculture and transport.

Tunisia is also supported by bilateral loan deals with the US and Japan that allow it to borrow at rates that are less than market value.

Aside from supplying cheap credit, pressure from the institutions offering Tunisia assistance has led to several reforms that should help to increase economic performance over the long term – including moves to rein in the country’s large subsidy bill.

Eyeing price hikes

On 1 July, Tunisia’s government cut fuel subsides, pushing the price of unleaded petrol prices up by 6.3 per cent to TD1.7 a litre.

Speaking to the state news agency TAP ahead of the price hike, Industry Minister Kamel Ben Nasr said planned cuts to fuel subsidies would save the government TD350m over the course of this year. The minister said the government is targeting a reduction in energy subsidies from TD3.6bn in 2013 to TD2.5bn.

Austerity reforms have proven to be a sensitive issue in the country. In January, strikes and protests turned into riots after an attempt to increase taxes, and the unrest forced the government to suspend its decision.

Tunis has accompanied its latest price hikes with a programme to support vulnerable households and mitigate the impact from the price hikes on the poor. It includes a higher minimum wage and steps to introduce a social identification number that the government hopes will improve efficiency of the welfare system. But there are concerns the support for the poor will not be effectively implemented.

“The government isn’t sufficiently addressing the problem,” says Bill Lawrence, director of Middle East and North Africa (Mena) programmes at the local Center for the Study of Islam & Democracy. “Part of the problem is that the government is transitionary and hasn’t got a full mandate to make sweeping changes. Mehdi Jomaa [the caretaker prime minister] is working with one hand tied behind his back.”

The programme to cut subsidies has been welcomed by the IMF. In its 16 July statement, it said the ongoing reduction in energy subsidies is “necessary to lower energy consumption and create fiscal space for priority spending on health and education”.

Banking reform

Overhauling Tunisia’s banking system is proving to be a particularly difficult area of reform. The country has committed to recapitalising its three large state-owned lenders in an effort to make more credit available to the private sector, something the government hopes will boost growth and create jobs.

Under the former regime, banking was badly monitored and the large state-owned banks, which represent 36 per cent of the banking sector, were used as policy tools, lending to projects and businesses that were favoured by the regime regardless of their creditworthiness. This led to the accumulation of bad debts. The turmoil of the revolution further undermined bank balance sheets due to their exposure to sectors such as tourism and companies owned by Ben Ali’s family and inner circle.

All this pushed the public banks’ non-performing loan (NPL) ratio to 21 per cent at the end of June 2013.

In order to get the banks lending again, the government has committed to restructuring and recapitalising them over the course of 2014 and 2015,

Speaking last summer, Laurent Gonnet, a financial sector specialist at the Washington-based World Bank, predicted that the planned reforms would push TD17bn-TD20bn of credit into the economy over the following decade. But over the short term, it is likely to exacerbate the country’s fiscal problems, with the US’ Fitch Ratings estimating it will cost between 2 and 3 per cent of GDP.

Germany’s Deutsche Bank says banking reform should remain a priority in Tunisia’s efforts to put its economy back on track, but notes that reforms are going to make reducing its deficit, another key target for the country, much harder to achieve.

In its 7 May report on the country, the bank said that due partly to the announced recapitalisation of three state lenders, it expects “the fiscal deficit to remain elevated at above 5 per cent of GDP in 2014”.

Promising outlook

With solid support from international institutions and ongoing reform programmes focusing on key trouble spots, the outlook for Tunisia’s economy holds promise, but it also remains vulnerable to a wide range of factors that policymakers are only beginning to deal with.

The country’s powerful trade unions were a significant factor in ousting the Ben Ali regime, and played a key role in resolving the 2013 political crisis. But as the economy attempts to get back on its feet, the unions are also proving to be a weight around its neck.

Since the revolution, industrial action has proved to be a constant challenge to businesses, with frequent strikes and protests shutting factories across the country.

Danger also lurks in the public banks’ shadowy balance sheets. If the planned recapitalisation requires more funds than expected, it will be even harder to cut the budget deficit and will push the country closer to default.

The plan to reduce the budget deficit is also vulnerable to any setbacks in subsidy cutting and failure to revive the tourism and manufacturing sectors.

Although all these risks are worrying, the danger of the upcoming elections renewing political tensions and failing to form a coherent government towers above all other risks as the key precondition to economic stabilisation.

Fair and peaceful elections would mark the successful end of Tunisia’s democratic transition. If it succeeds, it will set the scene for stable growth. If the elections fail, the political chaos that will ensue is certain to be accompanied by an escalation in the country’s economic crisis.