Emerging Markets, May 2015
Tunisia is often cited as the one true success story of the Arab Spring: a country that has undergone a peaceful transition to democracy, including an open and respected election. This is true. But it’s also a country facing considerable social and financial challenges.
“On the positive side of the balance sheet, what Tunisia has achieved is significant,” says Patrick Raleigh, associate director at Standard & Poor’s Ratings Services (which no longer rates the Tunisian sovereign but continues to monitor the country and its banks closely). “On the political front, the transition dragged on but they got there and held elections. Success here is relative, and one only needs to look elsewhere in the region to see what a bad transition looks like.
“But there are strong qualifications to that. The economy has suffered; FDI fell off a cliff in the year of the Arab Spring, 2011, and is still significantly below the level it stood at before the revolution; it has a big fiscal deficit, a big current account deficit, a shaky banking sector, social challenges, union unrest, and a lack of economic opportunities.” Indeed, one could argue that at this moment, the peaceful political transition is all there is to be excited about.
Among the investable MENA region – leaving Libya and Algeria as beyond the reach of all but the most risk-fixated investors – only Egypt has fallen further in ratings terms than Tunisia has since December 2010. At Moody’s Investors Services, it has fallen four notches since then, from Baa2 to Ba3, and is rated negative at that level. It averaged just 1.9% GDP growth from 2010 to 2014 – compared to 3.5% in Morocco and 2.7% in Egypt – and among its natural peers, only Lebanon has a higher level of government debt relative to GDP.
Additionally, while its democratic process proved itself to be peaceful with the elections late last year and the transition of power to President Beji Caid Essebsi, Tunisia has been afflicted with violence just like its neighbours. The March 18 Bardo Museum attack, which killed 21 people, many of them European tourists, clearly illustrated the threat the country faces, and will further damage a vital and weak tourism and real estate sector.
There are reasons for optimism, but only after looking past a lot of problems. “Tunisia remains conducive to economic growth,” says Albert Arbuthnott, an analyst specializing in North Africa for Salamanca Group. “A large, well-educated, youthful workforce desperate for employment opportunities and an escape from the poverty cycle serves as the backbone for this drive. But as Tunisia’s first democratically elected government begins its term in office, it faces the greatest challenge to the economic and political stability of the country.”
To Arbuthnott, it’s the militant threat represented by the Bardo attack that is of greatest concern, and any deviation from the political stability Tunisia has achieved so far will only make the militant problem more potent. “The threat of militancy in Tunisia is intrinsically tied to this stability,” he says. “This is particularly evident in the north-south divide in Tunisia, in which the unemployed, disenfranchised youth of the neglected southern interior are drawn towards the appeal of extremist Islam as an expression for their disgruntlement.” Economic prosperity – insofar as it exists anywhere in Tunisia – has to percolate from the coast to the interior to avoid militants gaining broader support.
This is particularly true because Tunisia’s physical location is perilous. It has, for years, contained the militant threat to the Chaambi Mountains, by the Tunisian-Algerian border; Tunisian forces have long recognised this as a focal point of militant activity so have focused their efforts there. Now, though, neighbour Libya is at least as big a problem, and security forces are overstretched.
And, naturally, the security situation isn’t just about security. It has a major impact on investment. “Tunisia has a lot of potential, but is extremely challenging from a security perspective,” says Simon Toms, partner at Allen & Overy, who advises on African private equity investment. “If the country is not already going strongly, security does make people thinking twice before taking investments forward, when they’ve got other places they could invest.”
Nowhere is hit harder than tourism, and that’s exactly where Tunisia needs growth. “Tourism has been a major part of the economy,” says Raleigh. “Its contribution in terms of jobs is even more significant than its contribution in GDP. There are a lot of people directly and indirectly employed in tourism, and the awful tragedy of Bardo presents a serious problem,” not just for tourist arrivals but for the foreign investors who might fund the development of further infrastructure.
The collapse in the tourism industry, in turn, creates other problems, notably in the banking sector. Standard & Poor’s recently reduced its banking industry risk assessment from group 8 to group 9, with the bigger the number, the worse the situation – and the scale only goes up to 10. It estimates that NPLs at the end of 2014 were equivalent to 16% of total loans; a quarter of those bad debts were from the tourism industry. Worse, the coverage ratio is only 60%, and there are a number of other problems besides: Moody’s says leverage is high, with a loan to deposit ratio of 114, and liquidity is tight. Moody’s Analyst Olivier Panis also points out that the 16% NPL figure actually represents two different stories, public and private, and that on the public sector side the bad loan total is more like 20%.
Tunisia is not blind to the problems it faces, and there are attempts underway to address them, but they are not coming quickly enough. For example, the government has set aside 1.3 billion Tunisian dinar to help to recapitalize Tunisia’s three big struggling public sector banks, which had fallen below minimum capital adequacy ratios after being told to take on greater provisions for their NPLs. Additionally, a new asset management company is expected, which will take out those problematic tourism sector debts – a quarter of all bad loans, remember – and restructure them, chopping the overall NPL ratio to 12% with the potential to help with other problematic debts in time.
“The problem is the delay in implementing these reforms,” says Mohamed Damak, global head of Islamic finance and director in the financial institutions sector at Standard & Poor’s. Neither of those measures has yet been implemented and it’s not entirely clear when they will be. “It will definitely help the banking system once they are in place,” says Damak. “Public sector banks will be recapitalized, asset quality indicators will improve, and the industry will get back to a comparable level with other emerging markets. I think it’s probably a question of time and capacity.”
Other problems in the banking sector seem more intractable. There had been a plan underway to merge the three public banks; it appears now that there is no longer any intention to consolidate them. “The government could have shown the way to the private sector by consolidating the public sector banks, giving them some incentive to talk and merge,” says Damak. That would be helpful: there are more than 20 banks serving a population of 10 million. But it’s not easy. “Ownership is dominated by a few industrial families. We don’t think consolidation will come in the near future.”
There are, though, moments of brighter news. Inflation is under control, international reserves have picked up and growth is at least positive; indeed, Moody’s predicts 3.5% growth in 2015 and 4.5% in 2016. “Any crisis presents opportunity,” says Raleigh. “A weaker dinar against the euro than before the Arab Spring, and lower wages in some sectors, has made some elements of Tunisia’s economy more competitive.” If visitors can get comfortable with security, then tourism remains the great hope. “There are not many mid-haul locations which offer winter sun from Europe which are considered safe and have the requisite amenities. It has the climate, the beaches, the culture. Tunisia has some trump cards and it is only a matter of time before these are fully realised.”
It’s also worth noting that our mental picture of tourism should not just be cold Europeans looking for a beach in November. “It’s important to mention that more than 50% of tourism inflows are coming from neighbouring countries – Algeria and Libya – and this flow has proven to be quite resilient in the past,” says Damak.
While Tunisia’s near neighbours give cause for concern, one can make a case for its location – very close to Europe, but also to the rising economies of sub-Saharan Africa – being long-term positive, when combined with a well educated workforce with a relatively strong representation of women for the Arab world.
Tunisia’s US$ 1 billion bond in January was a clear sign that investors have sufficient faith in the country’s long-term story to invest in it. The 10-year bond, done under Tunisia’s name without a guarantee from any other agency, attracted $4 billion of orders through Citigroup, JP Morgan and Natixis, with bookrunners reporting that the peaceful election was a considerable draw card (plus a 5.875% yield). “There’s clearly good market interest there,” says Raleigh, “though whether that would percolate down to local blue chip companies is another question.”
It’s also encouraging that Tunisia, as something of a shining light of emerging democracy, has the unquestioned backing of a great many multilaterals. Tunisia is under a standby agreement with the IMF for US$1.6 billion, although not all is yet dispersed because of the delays in reform. Other institutions, including the African Development Bank, have also tried to help, and the Gulf states are perceived as being behind them. “We see Tunisia as a country that has been well supported by the international community during this transition,” says Olivier Panis, senior analyst in the financial institutions group at Moody’s. “And it has a close economic and political relationship with the EU. If the structural reforms agreed with the IMF and World Bank are implemented, it will be positive for the banking system.”
That said, there’s plenty those multilaterals would like to see done. The World Bank’s most recent report on Tunisia, entitled The Unfinished Revolution, presents a laundry list of necessary reforms, among them removing barriers to market competition, improving the regulatory environment for investment, reforming the banking sector to increase the level of credit to the private sector by 10% of GDP, reforming the bankruptcy regime, strengthening the social protection system, improving labour market rules and institutions, and revamping the industrial policy. (The list actually continues some way beyond this.) Still, support is welcome. “There is support there – moral, financial, logistical,” says Raleigh. “That will help them push through tough reforms.”