Abstract
This paper examines the relationship between fiscal and external balances in MENA oil versus non-oil countries in the context of the twin deficits hypothesis (TDH) using Panel Vector Autoregression- Generalized Methods of Moments PVAR GMM estimation, Granger Causality and IRFs. The essence of this analysis is to assess the vulnerability of fiscal and external balances to oil price dynamics and regional geopolitics in the region. Results show that a twin-deficit problem exists in MENA oil-rich countries only while the problem does not exist in non-oil ones. This affirms the hypothesis that oil dependence results in high fiscal vulnerability to geopolitical shocks that automatically transmits to external balances. While a TDH isn’t proven to exist in non-oil countries, fiscal and external balances problems result from longstanding structural factors. A high reliance on tourism revenues and remittances as main sources of foreign currency receipts (together with poor tax administration and enlarged current spending bills) makes those countries more vulnerable to domestic and external shocks; reflected in both growing fiscal and current account deficits. A large imports sector and relatively poor exporting capacity also contribute to weakening external accounts. The main policy recommendations for MENA oil-rich countries rely in the importance of strengthening the non-oil sector in order to diversify domestic sources of revenues. Adopting flexible exchange rates is recommended to decrease the vulnerability of the external shocks to oil price dynamics. For non-oil MENA regions, fiscal consolidation, reforming current spending and strengthening tax administrations are crucial to improve fiscal performance. Export-led growth strategies and inclusive growth policies would also contribute to improving external accounts in the examined economies.
Highlights
The relation between fiscal and current account balances has been proposed in contemporary economic theory and examined widely in empirical literature under the commonly known term “twin deficit hypothesis (TDH)”
The twin deficits hypothesis (TDH) has been widely examined in literature, and different results exist relative to the presence and the direction of the relation between budget deficit and current account deficit
The TDH was originally examined by Milne (1977), where he found that there exists a positive relation between the two deficits using a simple single equation model where budget deficit was found to affect current account deficit
Summary
The relation between fiscal and current account balances has been proposed in contemporary economic theory and examined widely in empirical literature under the commonly known term “twin deficit hypothesis (TDH)”. Budget deficit affects the economy through high interest rates, low savings and low economic growth This hypothesis constituted the basis for the Mundell–Fleming framework (Nargelecekenlera and Giray 2013). We investigate the twin deficit hypothesis in the MENA region by empirically examining the relation between fiscal balance and external account balance in 10 MENA countries. We group the sample countries into two groups: oil countries versus non-oil countries This distinction is essential, as the MENA region has been affected by many factors in the past decades (such as oil prices, economic structure and state policies (Aristovnik 2007).
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