As a Matter of Finance

• Author: Adolfo Barajas and Ralph Chami
• Position: a Senior Economist in the IMF's Institute for Capacity Development, and is a Division Chief in the IMF's Middle East and Central Asia Department.

To help boost economic growth, Arab countries need a stable supply of funds and better access to credit

The Arab Spring ushered in a dawn of change across many countries in the Arab world. Discontent drove the demonstrations, and later the discourse. Now a new world has begun to develop in a number of countries still in varying states of transition.

Though it is still too early to reach definitive conclusions as to what drove the awakening across the Arab world, it is quite clear that the pace and quality of economic growth in the Middle East and North Africa (MENA) for several decades lagged far behind that of other developing economies (see Chart 1) and failed to deal with socioeconomic inequalities that fueled social tensions.

Although it has picked up since 2000, economic growth in the region is still lackluster and therefore of significant concern to policymakers. Several studies have uncovered a number of contributing factors, including subpar institutional quality, the difficulty of doing business, high rates of government spending, and lack of trade openness.

More recently, the limited effectiveness of the financial sector has been identified as an additional factor holding back long-term growth. By taking stock of the current state of finance following the Great Recession and reviewing its role in promoting growth, a picture begins to emerge of the challenges facing MENA countries when it comes to the promotion of financial development.

Emerging from boom and bust

Like much of the world, MENA countries experienced a marked acceleration in bank lending beginning in the mid-2000s. Until 2008, banking systems in most of these countries expanded credit to the private sector at a very rapid pace, often far above the rate of growth of the real economy. Recent analytical work found that eight countries in the MENA region were in the midst of a credit boom at some point around 2008, in the sense that the ratio of credit to GDP had surpassed the historical trend by an extraordinary margin (Barajas and others, 2011). At the same time, the region as a whole, along with sub-Saharan Africa and central and eastern Europe, was experiencing a generalized credit boom.

But with the global chain of events unleashed by the Lehman Brothers failure in September 2008, the ensuing drying up of funds—both domestic and foreign—contributed to equally spectacular declines in the growth of credit. For example, after peaking at over 26 percent in mid-2008, credit growth in Bahrain slowed to just over 4 percent by the first quarter of 2010. In Jordan, credit growth plunged: it grew faster than 14 percent in 2008 but contracted by 2 percent in the first quarter of 2010. This general pattern was observed in most of the region, more markedly among oil exporters and in the high-income Gulf Cooperation Council (GCC) countries in particular.

More recently, although credit growth...