Financing development in the Arab region

Financing is a prime determinant of progress to achieve the 2030 Agenda. Yet, the Arab region’s financing patterns remain, for the most part, unaligned with long-term sustainability horizons. Even prior to the COVID-19 outbreak, financing propensities were subdued as the region contended with cascading crises and a systemic financing-reflux where for every $1 the region gained, it lost $2.5 on average.

Domestic public revenues hinge on volatile oil and natural resource prices, a situation that epitomizes the low levels of diversification, or rather de-industrialization, in the Arab region. Direct tax revenues are subdued as tax systems continue to rely on regressive indirect taxation, and suffer from low tax morale and compliance. Public revenue generation remains less than ideal as more productive capacities slip into informality. Tax collection inefficiencies permeate across different tax brackets and tax systems. Fiscal balances are predominantly in negative territory given the overly generous and inefficient targeting of subsidies; sluggish public investment multipliers; and significant tax leakages arising from multiple tax abuses, such as tax evasion, tax avoidance, tax non-compliance, tax arbitrage and excessive tax expenditures.
The Arab region is said to be losing $7.5 billion annually owing to corporate tax abuse and profit shifting by multinational corporations. These losses amount to 6 and 11 per cent of the region’s expenditures on health and education, respectively, with $7 trillion of private wealth hidden in tax havens. Add to the above, the $77 billion lost each year owing to trade-based illicit financial flows. In sum, all these distortions have effectively undermined fiscal autonomy and the integrity of Arab tax systems.

Cross-border flows, notably foreign direct investment (FDI), have been declining since registering an all-time high of $88 billion in 2008. Capital outflows surpassed cross-border inflows, effectively turning the Arab region into a net exporter of capital (for every $1 gained, the Arab region lost $1.5 on average in FDI and primary income outflows between 2011 and 2018). FDI remains below the region’s potential, and is influenced by political instability and structural distortions. Domestic private investments remain subdued as Governments face challenges to crowd in private finance, be it in the form of public-private partnerships (PPPs), blended finance, or environmental, social and governance (ESG) investments. The sluggish monetary-fiscal policy interaction continues to create biases and disincentives for private investment. Moreover, distorted terms of competition create an uneven playing field favouring public sector and State-owned enterprises.

Remittances, another vital source of income for middle-income Arab economies and a lifeline for over 26 million migrant families, have been on the rise, predominantly driven by intraregional remittances that account for two thirds of the region’s remittances flows. In contrast, remittances from foreign sources stagnated (by 2018, for every $1 Arab countries generated in remittances, the region repatriated $2.2 on average to other regions). High-cost remittance corridors are dominant in the region, and remittances are predominantly channelled to consumption, real estate and to support out-of-pocket health and education expenditures, with small portions going to capital and productive investments.

The Arab region also suffers from a host of lost opportunities in financing, given the heavy banking footprint in deficit financing that raises the spreads for the private sector to tap liquidity. The situation is aggravated by a wave of de-risking and losses in correspondent banking relationships (CBR). The Arab region witnessed a 25.6 per cent decline in CBR, and a 29.3 per cent decline in the ratio of counterparties abroad to local banks transacting payment messages. The region is also witnessing other forms of lost opportunities in financing arising from excessive military expenditures ($76 billion per year on average above global averages). Official development assistance (ODA) channelled to direct budget support and to finance critical social sectors has been declining, and concessional portions have regressed to single digits, raising questions on whether ODA was a contributing factor to the region’s debt build-up. In addition, the region’s rising humanitarian financing gap places added pressure on the already over-stretched national public service infrastructure in host countries.

Financing propensities are also subdued given the untapped export potentials, running as high as $162 billion. The low levels of intra-Arab trade (including in services trade) and the proliferation of non-tariff barriers and regional instability have led to a rise in spreads and in the cost of trade finance. The Arab region’s gross public and external debt stocks continues to swell, with substantial debt inflows acquired to offset rising finance and fiscal constraints. Since 2011, Arab countries have generally witnessed rising levels of external debt. Between 2011 and 2018, the Arab region became a debt service financier, with $1.63 being paid back in arrears on outstanding debt stock for every $1 of debt inflow.

To tackle these challenges, ESCWA, in collaboration with other SDG-implementing entities, and under the auspices of the Secretary-General of the United Nations, and the prime ministers of Canada and Jamaica, has advanced over 150 financing options to mitigate the short-term impact of COVID-19 and ameliorate its long-term consequences, in line with the 2030 Agenda. At the regional level, ESCWA developed the first regional emergency response strategy to mitigate the impact of the pandemic. A series of thematic policy briefs followed to analyse the impact of the pandemic on the region, covering several Arab financing priorities areas, including FDI, remittances, fiscal space, financial markets, debt sustainability and the economic cost of COVID-19.

The 2021 Arab Forum for Sustainable Development contextualized the proposed FfD policy options and accelerated progress on the 2030 Agenda. In addition, ESCWA assessed the implications of rewriting the global tax rulebook and the implications of taxing the digital economy on the Arab region. At the national level, ESCWA is providing technical backstopping to United Nation country teams in the region, and is supporting the preparation of common country assessments, and measures of public investment efficiencies. It is also advancing work on the development of integrated national financing frameworks (INFFs), which offer a detailed anatomy and analytical diagnostic of financing instruments, channels, and non-financial means available to mobilize the optimal aggregate mix of resources to support SDG-financing. ESCWA is also supporting Arab economies by providing dedicated capacity-building support and advisory services, notably on taxation and domestic resource mobilization. Moreover, it is developing a set of normative tools to help policymakers overcome major financing rifts, including dedicated national financing and SDG costing simulators to support the development of national financing strategies.