Emerging Markets: How ISIS has Affected MENA Economies

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Emerging Markets, IMF Editions, October 2015

The steady rise of ISIS has caused shockwaves across the Middle East. The impact varies considerably from place to place – civil war at one end, indifference at the other – but nowhere in the region can truly claim to be unaffected.

Naturally, the most extreme effect is in the places where ISIS has a stronghold, most obviously Syria and Iraq, but to an extent Libya too.

The situation in Syria is so bad that few rating agencies or economists even cover it anymore. One can argue about whether this is most directly an impact of ISIS, or the civil war with the Assad regime that precipitated it, but in aggregate the outcome is bleak in the extreme.

David Butter at the UK-based Chatham House group released a detailed study of the Syrian economy in June, concluding that the Syrian economic output – measured by GDP at constant prices – had fallen 60% over four years of conflict, during which time the national population had shrunk from 21 million to 17.5 million through refugee flows, a quarter of a million had died, and one third of the remaining population had become internally displaced.

“The conflict has pervaded all aspects of the economy,” says Butter. “Agriculture has assumed a dominant position in overall production as other sectors have been devastated, but farm output has also been severely affected.” Oil production under state control has dropped from 387,000 barrels per day to less than 10,000, while ISIS controls oilfields with the capacity to produce 60,000. Effective electricity generation – mostly powered by natural gas – has fallen more than 70% since 2011. The capture of Palmyra, quite apart from devastating hopes of a revived tourism sector when peace eventually returns, also threatens the government’s phosphates exports, which were worth $100 million even in war-blighted 2014. The Syrian pound has lost about 80% of its value since the conflict began.

Next door in Iraq, though, the economic situation is not as perilous as one might assume. “The impact of ISIS on Iraq has not been as devastating as you would think,” says Ravi Bhatia, director at Standard & Poor’s. “Iraq is basically a large oil economy: more than 90% of its exports are oil, its fiscal revenues are almost all oil-related, and more than 50% of its GDP is oil.” Fortunately, most of its biggest oil installations are in the south, in the Shia areas and mainly near the Kuwait border; the areas ISIS controls are in the northwest, where there is much less production, although it has gained control of some pipelines. Iraq has actually ramped up oil production impressively in recent years, and S&P expects it to reach 5 million barrels per day by 2018 from 3.1 million in 2014. “ISIS has not totally devastated the oil economy, put it that way.”


Nevertheless, S&P – which rates Iraq B- for long-term foreign and local currency sovereign debt, B for short-term, and expects real GDP growth to average 5.7% from 2016 to 2018 from just 0.3% in 2015 – says that ISIS constrains the rating. “In our view, Iraq faces security and institutional risks that are among the highest of all rated sovereigns, stemming primarily from its war with ISIS,” the agency says. It notes, too, that military and humanitarian expenditure related to the war has hit public finances, and that consequently the general government fiscal deficit will reach 18% of GDP in 2015, from 5.5% in 2014.


This, incidentally, has raised slightly troubling moral issues for debt capital markets investors. At the time of writing Iraq was expected to raise up to $6 billion any day through bond issues, and it’s hard to argue that at least some of that money isn’t going towards waging a war (even if one accepts the use of funds as general budget or fiscal deficit purposes, that’s still a consequence of conflict).


Libya’s problems are more complicated than just ISIS, with a devastation caused by differences between numerous clans, factions and even governments (there are, at the time of writing, two which believe they run the country, alongside two different people who think they run the Libyan Investment Authority sovereign wealth fund). “Libya is a country divided,” says Richard Cochrane, senior analyst at IHS Country Risk. Neither of the two governments “fully controls the military forces that are ostensibly aligned with them,” he says, and military conflict “has instead shifted to the political level through the creation of parallel institutions, risking a permanent partition between east and west.” Even if ISIS didn’t cause this, it has taken advantage. “Jihadist groups, which have grown steadily in capability over the last four years, have stepped into this power vacuum. In particular the Islamic State has carved out a solid foothold in Libya around the central city of Sirte since late 2014.” The ISIS challenge here is in some sense latent: it’s the fact that it will be a haven for militants wishing to attack their neighbours (notably Egypt and Tunisia) and elsewhere, and that it won’t be challenged until there is a unity government – which, even if you believe there will be a unity government anytime soon, will both distract Libya and drain its resources.


But what about the rest of the region?


The most obvious impact is through trade. Elena Ianchovichina at the World Bank, who co-authored a December report on the economic impact of the Syrian war and the spread of ISIS, calculated then that the six economies of the greater Levant collectively – Syria, Iraq, Lebanon, Turkey, Jordan and Egypt – had by then lost almost US$35 billion in output, an aggregate cost equivalent to Syria’s entire GDP in 2007.


Take, for example, trade between Turkey and Iraq– an important route, since Iraq has become Turkey’s second biggest export market after Germany and accounted for $12 billion of sales last year, chiefly to Kurdistan. Any truck that wants to get to the south of Iraq now needs to go via Iran, adding 1,000 kilometres to the journey and $2,000 of costs per truck. That either stops trade happening, or increases costs, particularly for food. Disruptions like this are causing severe penalties to regional trade, which had been increasing: the World Bank says that trade between seven regional territories (those mentioned above plus Palestine) averaged $29.7 billion a year from 2008 to 2010 compared to just $4.2 billion a year from 2000 to 2002; figures since then are harder to quantify but are believed to be declining.


There are other impacts on the Levant. Both Lebanon and Jordan have had to absorb vast increases into their populations through refugees or migrants, in Lebanon’s case adding one third to the number of people who need to be fed and occupied. The economic effect, though, is not clear cut. “Influxes of refugees into Lebanon, Jordan and Turkey have boosted consumption, investment and labour supply, and therefore the size of these refugee-receiving economies,” says Ianchovichina. “But, in all cases, aggregate incomes have increased less than the size of the population, so the war has hurt the standards of living there, with per capita average incomes declining by 11% in Lebanon and 1.5% in Turkey, Egypt and Jordan relative to levels that could have been achieved had the war been avoided.” For Egypt, Jordan and Turkey, she says the bigger cost is the lost opportunity of trade integration that was expected to have otherwise taken place under the Levant Quartet intra-regional agreement that was signed in 2010.


In North Africa, the clearest impact has been through terror attacks and the consequent impact on tourism. Tunisia is the most obvious example here: the attack on tourists at the resort town of Sousse earlier this year was followed by a decision by the UK, among others, to get tourists out of the country and to advise them not to go back. Tunisia brings about 20% of the hard currency into the country, accounts for about 14% of GDP and 12% of employment. All of these variables then have knock-on effects. For example, tourism NPLs have blighted the health of the banking sector; this will make it worse. An absence of employment opportunities among the young threatens not only the economy but social harmony and political stability; this will make it worse.


Egypt has so far avoided the worst of ISIS, but they know it’s on its way, and its attempts to avoid such an event had a tragic outcome in September when security forces attacked what turned out to be a convoy of Mexican tourists, believing it to be militants. Egypt is also dependent on a successful tourism sector, which has been blighted for years through its two revolutions anyway.


Further afield in the Gulf, Kuwait was shocked by an attack on a mosque there earlier this year, though this appears to have had limited impact in either an economic or a social sense. “The Shia and Sunni communities rallied together and put it behind them,” says Bhatia. “This is the first terrorist attack in Kuwait since the 1980s if you exclude the Gulf War.” In other Gulf states, it’s more of a question of concern, and perhaps increased spending to make sure security forces are ready: ISIS has a stated aim of wanting to get the royal family out of power in Saudi Arabia, for example, and the high numbers of tourists who visit the UAE – most obviously the resorts of Dubai – must also be cause for concern.

Chris Wright
Chris Wright
Chris is a journalist specialising in business and financial journalism across Asia, Australia and the Middle East. He is Asia editor for Euromoney magazine and has written for publications including the Financial Times, Institutional Investor, Forbes, Asiamoney, the Australian Financial Review, Discovery Channel Magazine, Qantas: The Australian Way and BRW. He is the author of No More Worlds to Conquer, published by HarperCollins.

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