The political upheaval in the Mediterranean region is exceptional and new to a politically dormant region. While there are uncertainties on the political evolution of the countries concerned, one reality that cannot be argued is that things will never be the same again in this side of the Mediterranean.

Following the revolutions that were led by youth throughout the territory, both Egypt and Tunisia witnessed a change in their history:  the falling of long-lasting autocratic regimes signalling a new age for these countries that is about to flourish: an ‘Arab Spring’.

The two countries share two common elements that constitute the root-causes behind the upheavals we have witnessed: (i) political and social exclusion, where alliances between the state political powers and a small privileged rent-seeking business elite were perceived as burying the hope for democracy and equality; and (ii) the somewhat economic gains achieved in these countries failed to translate into social gains, leading to increasing inequality and massive unemployment.

While the political transition towards democracy is not going to be easy for those countries, however it offers great hope for the future. Short term losses (economic, social and fiscal) are already taking place in these two countries, but the expected long term gains are so fundamental that the idea of a possible trade off is almost inexistent.

On this crossroad, the Egyptian and Tunisian political regimes can follow a route of reform towards democracy which will surely produce long-term benefits and a durable and more balanced growth, all the while bearing a period of short-term instability. On the flipside, if they are not sufficiently supported, they risk opting for more stability in the short-run, but to the detriment of democratic openness. Fortunately, it appears that the measures followed since the fall of the old regimes are oriented towards the first path which provides considerable optimism for the political future and for the long-term development of both economies. Put in more technical terms, one shall monitor the transitional effects on the J-curve to move as quickly as possible away from a situation of relative cyclical weakness towards a sustainable growth level. The situation is similar to that experienced during the transition in Eastern Europe, which was efficiently done with considerable support from other democracies and led to a real convergence with the rest of Europe .

1. Short-term immediate effects

In Egypt :

• Tourism loses amounted to at least $1bn since one million tourists left the country.
• Egyptian ports saw most their business move to neighbouring countries (Malta, Israel etc) since Egyptian docks remained  mostly closed following the domestic events.
• The Egyptian stock market had seen its activity interrupted. In end-January, Egyptian stocks had lost 20% of their value.
• Meanwhile, Moody’s Investors Service downgraded the ratings of five Egyptian banks and Standard & Poor’s downgraded its rating on Egyptian debt and warned that another cut was possible.
• Egypt’s revenues are driven by tourism (£7bn last year, that is approximately 0.82bn Euros), and taxes on ships using the Suez canal generated £6bn in the last financial year. But Egypt still had to borrow to cover a current account deficit. Hence, a probable fall in tourism and exports (more than 10% of GDP) will greatly affect the budget deficit.

In Tunisia :

• Riots had already cost 3 billion dinars to the economy (1.6 billion euros), equivalent to 4% of GDP. About 2 billion dinars due to the stop of domestic economic activity and 1 billion due to the stop in exports.
• Tourism, representing 6.5% of GDP (and employs about 400,000 people) is greatly hit and could lead towards more unemployment (13% in 2010, estimated by EIU at 16.6% in 2011). Thousands of tourists flee out of Tunisia. Tour operators have asked for an emergency plan to re-launch Tunisian tourism.
• Moody’s Investors Service downgraded the global local currency (GLC) and foreign currency (FC) deposit ratings of five Tunisian banks. « The rating reviews reflect concerns about the potential impact of the social and political unrest on the economy and, ultimately, credit conditions ». This will necessarily have an impact on borrowing costs from international capital markets.

Regarding the political short-term ramifications, the transitional governments removed all traces of the old regimes, including ministers, dissolved the parliament and sent to justice close associates linked to these authoritarian regimes. Moreover, in both the Tunisian and Egyptian case former political prisoners were released. It appears that in both countries, interim authorities have shown political flexibility and determination which hints at a political future full of optimism. Both societies seem to want to evolve towards real democratization with increased civil liberties, and especially greater female participation.

2. Economic policy and macro expectations :

A lower economic growth, due to a fall in exports, tourism and FDI (and Suez canal receipts for Egypt) coupled with higher inflation is expected for 2011. Also, a higher current-account and budget deficits (EIU estimates) are to be anticipated.

In Egypt :

• Initial plans to develop the private sector will be delayed. The new government will need to increase social transfers and adopt stabilization measures. It will also need to maintain supplies of essential goods and services to the population and create employment position (ex. in public works).
• Economic growth should fall to 3.5% in 2011 (versus 5.1% the prior year).
• Inflation attained 11,1% in 2010, as food prices increased, it could climb to 14.7% in 2011.
• Tourism and Suez canal revenue declines and deterioration of the trade balance should bring a 4.9% current account deficit (versus a 1,3% deficit in 2010).

The new government will be constrained by revenue limitations; the budget deficit in 2010 was at 8% and should climb to 12% in 2011 due to high spending on subsidies and public works. Liberal economic reforms can probably only occur after stability is imposed.

Meanwhile, in Tunisia

• Plans to reduce subsidies and increase taxes seem inappropriate. The new government will need to increase social transfers and subsidies to prevent more riots. However, Tunisia has a large budget deficit (estimated to have reached 5% of GDP in 2010). The budget deficit will increase to about 9.5% of GDP in 2011 and will have to be contained later on.
• Economic growth should fall to 0.8% in 2011 (versus an estimated 3% initially).
• Inflation attained 4.4% in 2010, as food prices increased, it could climb to 5.3% in 2011.
• Tourism revenue declines and deterioration of the trade balance should bring a gigantic 14.2% current account deficit (versus a 2.4% deficit in 2010).

The interim government shall maintain high spending, but it will be constrained by revenue limitations, such as the case of Egypt. It will seek to boost investment and, provided that stability is restored, domestic private investment will expand more rapidly. FDI should be of major importance if anticipations become positive again. In this regard, something positive must be stressed: investment funds, currently facing the greatest difficulty in achieving planned fundraising, highlight the strong willpower for growth on the behalf of SME-SMI officials. This determination was burdened in the past by fear of authoritarian regimes capturing business rent and interfering in management and ownership when firms exceeded a certain size. Now this risk has disappeared which is extremely positive for business development. Meanwhile, the Tourism Ministry launched the ‘I Love Tunisia’ campaign to attract foreigners and could reinstate hope for the sector’s growth.

3. Monetary policy :

Following the social unrest and its impact on the economy one should expect a series of monetary policy implications.

In Egypt :

• The CBE last cut its rates in September 2009. Now, the CBE will have the difficult task to control rising inflation facing inevitable government pressures to prevent interest rate rises.. It is very likely that inflation accelerates due to the depreciation of the Egyptian pound and rising commodity prices.
• In 2010, the Egyptian pound attained a five-year low against the dollar, possibly with interventions from the Central Bank (EIU). The pound could weaken further, averaging E£6.40:US$1 in 2011 (EIU).

In Tunisia :

• According to EIU Banque centrale de Tunisie will probably maintain a relatively tight monetary policy ensuring that inflation remains largely under control.
• In the short term, the central bank will focus on maintaining economic growth, particularly growth in exports, in light of weak expansion in the EU.
• The BCT decided to leave its key interest rate unchanged in December. It could use other monetary tools (ex. banks’ reserve requirements)́ to control the money.

• Full currency liberalisation will be delayed for some years (will require major reforms to the banking sector). Meanwhile, the BCT will take a more flexible approach by reducing its interventions in the foreign-exchange market. Given the EU’s debt problems, the dinar should appreciate, the average rate of the dinar is forecast to appreciate to TD1.73:Euro1 in 2011, reaching TD1.55: Euro1 in 2015. It should also appreciate against the dollar, to TD1.39:US$1 in 2011 and TD1.32:US$1 in 2015 (EIU). Nonetheless, this appreciation will keep making conjectural positive action of external demand more difficult.

Sources :

AnsaMed : « TUNISIA: TOURISM, TOUR OPERATORS ASK FOR EMERGENCY PLAN », January 28th.

Boursereflex (2011), « Egypte : coût économique élevé des troubles à court terme (Robeco) », February 2^nd.

Challenges (2011), « -Tunisie : les troubles ont déjà coûté 1,6 milliard », 19-1-2011.

EIU (2011), Egypt Country Forecast, February and April 2011.

EIU (2011), Tunisia Country Forecast, January and April 2011.

Guardian (2011), « Egypt’s vice-president complains rioting is bad for business », February 3rd.

Moodys (2011), « Moody’s takes action on five Tunisian banks’ ratings », January 21st.

Moody’s (2011), « Moody’s downgrades five Egyptian banks; on review for further possible downgrade », February 2^nd

NZHerald (2011), « S&P downgrades Egypt’s debt rating and says it could go lower », February 3rd.