July 2022

As the figure shows, inflation in most MENA countries was lower than in the United States, which is portrayed by the horizontal black line, and Europe—or would have been lower had exchange rates remained at their levels in February 2022. The two glaring exceptions are Lebanon and Iran, which even before the onset of the war in Ukraine had such high rates of inflation that they are presented on a different scale. In Lebanon, the post-February 2022 inflation would have been lower if its black-market exchange rate had been stable since February, although, at 68.4 percent, it would still have been very high. For Iran, the exchange-rate adjusted inflation rate was more than 33 percent. In both countries high inflation was present well before the onset of the war in Ukraine.

Because exchange-rate adjusted inflation rates in the region are lower than the headline inflation rates in the United States and Europe, the key analytical question is not why inflation has risen to previously unseen levels in MENA, but rather why inflation is not higher. The following section estimates the effect of policy responses since February 2022 on each country’s inflation rate.

Ì 3.a.ii. Estimates of the impact of tradable product-market policies since February 2022

As discussed above one reason why price increases of tradable items do not always fully pass through to domestic inflation is that government authorities tend to respond with product-specific policies, such as food and energy subsidies and price controls.

Figure 3.3. Estimates of the impact of tradable product-market policy responses on headline inflation, March–July 2022

Year-on-year inflation rate Year-on-year inflation rate: Iran and Lebanon

18 16 14 12 10 8 6 4 2 0

4.19 6.99 7.88

5.59

3.32 9.05 12.84 18.42

5.23 4.24 3.95 6.63 5.758.59

33.26 301.88

Djibouti West Bank and Gaza Morocco Iraq Jordan Tunisia Algeria Egypt, Arab Rep. Oman Bahrain SaudiArabia Kuwait Qatar Iran Lebanon

J Average y-o-y headline inflation rate J Average y-o-y policy change adjusted inflation rate ▬ US y-o-y headline inflation

Source: World Bank Staff calculations based on data from Haver Analytics and national statistical offices. Note: The United Arab Emirates is excluded because it does not publish monthly data for the current year. Libya, Syria, and Yemen are excluded due to lack of data. 300

250

200

150

100

50

0

Figure 3.3 shows the extent to which product-market policies implemented since February 2022 have affected inflation across MENA countries. The red bars represent average reported inflation from March to July 2022, while the orange bars show the counter-factual average inflation rate that would have been observed had there been no changes in product-market policies for the period March–July 2022. The effect of product-market policies on inflation is calculated by removing the impact of the exchange rate depreciation and global tradable inflation components from headline inflation. See Appendix A1 for a full derivation.

For most of the MENA countries in this sample, the counter-factual inflation rates would have been higher than the actual rates. In Egypt, for example, the average year-on-year inflation rate during March–July 2022 was 14.3 percent, but it would have been 18.4 percent if the authorities had not intervened in tradable product markets. That is, Egyptian government interventions reduced inflation by more than 4 percentage points. Only Djibouti, Iran and Jordan show evidence of having policy changes that resulted in a net increase in inflation. One potential explanation for the Djibouti and Jordan cases is that this was an unintended consequence of the imposition of price controls in these countries. Controls have ambiguous effects on prices, because they tend to be associated with growing scarcity and rising blackmarket prices. In addition, Jordan raised price ceilings on some products. Table 3.1 presents the estimated net impact of product-market policies implemented since the onset of the war in Ukraine. Most countries in the sample succeeded in attenuating domestic inflation in response to rising global inflation. That is the good news, but lower inflation came at a fiscal cost.

Table 3.1. Estimates of the net effect of product-market interventions on average national year-on-year headline inflation February–July 2022

Country Percentage Points relative to Observed Inflation Rates

Lebanon Egypt, Arab Rep. West Bank and Gaza Oman Algeria Kuwait Saudi Arabia Morocco Tunisia Qatar Bahrain -101.0 -4.1 -3.1 -2.4 -2.3 -2.2 -1.6 -1.5 -1.3 -0.8 -0.6

Iraq Jordan Djibouti Iran -0.2 0.9 2.2 4.5

Source: World Bank Staff calculations based on data from Haver Analytics and national statistical offices. Note: The United Arab Emirates is excluded because it does not publish monthly data for the current year. Libya, Syria, and Yemen are excluded due to lack of data.

3.b. What governments are doing in product markets to contain inflation

Governments from around the world are grappling with the socio-economic impacts of higher prices. Inflation, especially when driven by food and energy, tends to be socially regressive, exacerbating poverty. This is well understood in the literature (see, for, example Lederman and Porto 2016). In MENA, recent World Bank estimates suggest that the increases in food and energy prices since the outbreak of the war in Ukraine could raise the number of the poor by more than 20 million. For every 1 percent increase in MENA food prices, nearly half a million more people could be forced into poverty (Lopez-Acevedo et al. 2022).4

Some countries may have also been motivated to dampen prices of tradables out of a legitimate concern that higher food and energy prices could lead to social unrest. Bellemare (2014) provides evidence that rising food prices increased the risk of social upheaval. The author also highlights examples from history, noting that food riots are thought to have precipitated the French Revolution (Rudé 1964), the Russian Revolution (Wade 2005), and the fall of the British Raj in India (Arnold 1979). In the MENA context, the 2010-2011 food crisis saw food prices increase by 40 percent between January 2010 and February 2011, immediately preceding the outbreak of the Arab Spring (December 2010 to December 2012).

4 These estimates are likely understated because such simulations assume that inter-household inequality will remain constant at the level of the most recent household survey, which predates the current crisis.

Table 3.2 provides an overview of the types of product-market policies that have been implemented across MENA countries since February 2022. This list does not include standard macroeconomic policies, such as increases in interest rates, that are used to control inflation by supporting the national currency and/or reducing domestic aggregate demand. It also does not include policies aimed at securing access to imported food staples, which have been a priority for most countries that depended on direct imports from Russia and/or Ukraine before February 2022. It is through these searches for alternative supplies of food and energy that global markets adjust to the reduced global supply of grains, fertilizer, and hydrocarbons.

Table 3.2. MENA’s product-market and social transfers policy changes since February 2022

Product-Market Interventions

Increased Food and Fuel Subsidies Instituted New Price Controls

Trade Regulations Indirect Tax Exemptions ProductSpecific Exchange Rates Increasing Regulated Prices/ Reducing Subsidies Targeted Social Protection

Cash Transfers Utility and Financial Support Improved Targeting

Gulf Cooperation Council Oman 

Bahrain Saudi Arabia

 Kuwait  United Arab Emirates   Qatar

Developing Oil Exporters Syrian Arab Republic Yemen, Rep. Iraq Algeria Iran, Islamic Rep. Libya Developing Oil Importers Djibouti     

West Bank and Gaza    Morocco  Jordan       Tunisia   

Lebanon

    Egypt, Arab Rep.     

Total: Out of 19 8 10 6 5 4 5 7 7 3

Source: World Bank country economists and staff estimates based on news reports as of September 2022. Note: Countries are displayed in ascending order by 2020 GDP per Capita (PPP, current U.S. dollars) within country groupings.

Instead, the table focuses on policies that target domestic product markets—through changes in consumption subsidies, indirect taxes (or specific taxes on commodities), import tariffs, price controls, and the use of product-specific multiple exchange rates aimed at reducing the costs of particular imports.5 The table also lists changes in social protection

5 See Guenette (2020) for data and more analysis on price controls.

policies, which aim to provide relief directly to households struggling with higher food and fuel costs without altering the functioning of domestic product markets. The table draws on information provided by World Bank country economists supplemented by news reports. While likely incomplete, the table provides a qualitative summary of policies that can have opposing effects on domestic inflation.

Eight MENA countries increased food and energy subsidies to reduce the pass-through from global prices to domestic inflation. Almost every middle-income or lower-income oil-importing country announced increases in consumption subsidies. Cash-strapped Lebanon seems to be the only country in this group that did not. Although the enhanced subsidies depress domestic prices, they carry potentially substantial fiscal costs, which might have large consequences for economies with pre-existing fiscal and public-debt vulnerabilities.

Six countries—Egypt, Djibouti, Jordan, Tunisia, West Bank and Gaza, and Libya—imposed new price controls. Three countries (Egypt, Iraq, and Jordan) were reported to have loosened import restrictions on specific products to reduce the pass-through of global inflation to domestic inflation. Iraq is the only oil exporter to have instituted both enhanced subsidies and loosened import regulations. These policies can help attenuate domestic inflation but at the expense of less strict oversight of the quality of imports or a decline in government revenue if import tariffs are reduced.

Syria, Iran, Egypt, and Lebanon appear to subsidize imports by using product-specific exchange rates that make it cheaper to buy the targeted imports. Although subsidized exchange rates do not necessarily show up as fiscal expenditures, they are not cost free. At the very least they can reduce a central bank’s reserves and possibly weaken its balance sheet.

The last type of product-market intervention considered here is an increase in controlled price ceilings, which reduces the fiscal costs of the consumption subsidies. Tunisia and Jordan were reported to have implemented higher price ceilings (especially for food products, such as potatoes, chicken, turkey, and tomatoes in Tunisia and palm oil in Jordan) along with increases in overall consumption subsidies—in other words, subsidies kick in when the domestic price rises above a ceiling or threshold price. Because authorities can raise the ceiling while also increasing the subsidy, it is difficult to ascertain whether the net effect on domestic inflation is positive or negative.

Table 3.2 also identifies the countries that have strengthened their cash transfer programs. Cash transfers are unlikely to affect the domestic prices of tradable goods such as food and energy but could affect the prices of non-tradable goods. Our previous estimates of the influence of exchange rate movements and policy responses on headline inflation ignore these indirect effects on the prices of non-tradable goods, and thus we acknowledge that our estimates presented above are under-estimated.

Increases in both subsidies and targeted cash transfers are likely to show up as fiscal expenditures and could exacerbate pre-existing fiscal and public-debt vulnerabilities, especially among highly indebted oil-importing countries of MENA. Only Djibouti, Iraq, and Syria reported improvements in targeting, which likely reduces the fiscal burden of social transfers.

In sum, since February 2022, MENA governments have deployed a suite of specific policies to mitigate the damage from higher inflation, particularly in food and energy prices. These policies are separate from the standard macroeconomic policy responses, such as interest rate increases by central banks, which occurred in 10 countries. Most countries implemented some form of product-market intervention, and a few expanded or strengthened cash transfers. These

various policies can have contradictory effects on domestic inflation. Their estimated impacts are reported in Figure 3.3, which shows that the inflation reduction effects have been notable but probably small relative to the reported headline inflation rates. Even in Egypt, the 4 percentage-point reduction of domestic inflation through July 2022 was relatively small when compared to the 14 percent average inflation rate from February through July.

This raises the question of fiscal costs of these inflation-mitigation policies and whether the expenditures required to implement many of these policies are the most efficient use of scarce fiscal resources, especially for the oil importing countries.

3.c. The relative fiscal costs of compensation schemes

Targeting transfers to the most vulnerable families is less costly than providing across-the-board subsidies that benefit all households including the most well off. This section provides estimates of the magnitude of the relative fiscal costs of across-the-board subsidies compared to the fiscal costs of targeting the poorest.

Assuming that the entire effect of policy changes on observed headline inflation found in Table 3.1 works through food and energy prices, one can transform the total reduction in inflation into an equivalent direct support payment to the population to compensate them for the rise in food and energy prices.

For example, take Egypt, which (along with the West Bank and Gaza and Morocco) provides the best household survey data to conduct this type of analysis. The net effect of product-market interventions on average headline inflation was a reduction of 4.1 percentage points. Assuming that this was achieved by lowering only food and energy prices, the equivalent reduction of the combined basket of food and energy products can be calculated using the weight of food and energy consumption in national household consumption. For Egypt, where food and energy consumption represented 43.5 percent of total consumption in 2018, the 4.1 percentage-point reduction in average headline inflation translates into a 9.4 percentage point reduction in the total increase in prices of food and energy observed between February and July. Instead of using across-the-board product-market interventions, Egypt could have allowed bigger increases in the prices of food and energy based on market dynamics, while compensating the population for the additional 9.4 percentage point increase in food and energy prices. Thus, it is possible to produce a rough estimate of the fiscal costs of these product-market interventions. It is also possible to compare the relative costs of targeting just the poorest segments of the population (as with a targeted cash transfer system) with the cost of providing relief to the entire population (as with a general subsidy).

Figure 3.4 Panel A provides the results of this analysis for Egypt. The orange line plots the cumulative costs as a percent of GDP by household consumption decile of compensating the population for a 9.4 percentage point increase in food and energy prices. Compensating just the lowest decile would cost 0.086 percent of GDP, while compensating the two lowest deciles would cost 0.184 percent of GDP, up to a total cost of 1.136 percent of GDP if the entire population were compensated. The red line shows the relative costs of compensating the entire population, as with an across-theboard subsidy, compared to the costs of targeting the poorest. For the first decile, this is equal to 1.136 percent of GDP/0.086 percent of GDP or 13.2 times. For the first two deciles combined, it is equal to 6.2, and so on. Thus, it would cost 13.2 times more to compensate the entire population for a 9.4 percentage point increase in food and energy prices than to compensate just the lowest decile—a much larger fiscal cost.