Failure to implement swift reform will lead to the collapse of Tunisia, the birthplace of the Arab Spring. A financial disaster is already in the making. This concerning outcome stems from the course the nation has taken since President Kais Saied seized power in July 2021.
Two key aspects of economic policy serve as the foundation for this trajectory. The first is a massive (and costly) fiscal push that has resulted in four consecutive years with historically high deficits, driving the national debt to unmanageable levels.
The second issue is the government’s lack of support for economic activity, which is instilling fear in the productive sector and slowing down economic growth due to a deteriorating business climate and heightened macroeconomic risks.
Additionally, the mechanism that might trigger a financial storm is becoming more apparent. The government is being forced to borrow more money from banks, national bondholders, and the Central Bank to pay a larger portion of its deficit domestically as a result of the closure of external funding sources.
This is driving away private industry, slowing economic expansion, raising inflation, worsening the quality of bank balance sheets, and increasing the possibility of a significant devaluation of the Tunisian dinar. All conditions are set for a financial crisis impacting the banking sector, currency exchange rates, and national debt.
Saied’s populist appeal has been based on his public pledge to uphold two principles: staunchly opposing an International Monetary Fund (IMF) programme to prevent the hardships it would cause the populace due to austerity, and combating corruption by forcing the “corrupt business elite” to give up its allegedly ill-gotten wealth through a legal process that threatens to put business owners in jail if they refuse.
The populace, weary of a turbulent decade marked by a rise in domestic corruption and numerous external bailouts, has resonated with these two ideas. But Saied’s strategy has also resulted in a surge in debt and a slowdown in growth, both of which are currently hurting the economy.
A financial blowout is a real possibility as a result of all this. Tunisia is on the verge of depleting its financial reserves. Until the elections, there is no assurance that the situation will stay under control. If a financial crisis breaks out, the nation might face a terrifying combination of state insolvency, economic collapse, severe social harm, and significant political difficulties due to the need to distribute substantial losses across the population.
A decrease in economic growth and a worsening of social conditions, including lower real earnings and higher unemployment, have already been brought about by the consequences of bad policy. Due to these results, the government has increased the size of subsidies, which further solidifies the unsustainable nature of public finances and adds to a large fiscal imbalance.
As a result, the nation must make tough decisions. A bold reform programme to increase economic growth, strong and resolute political leadership to maintain social cohesion, and, ideally, assistance from Tunisia’s international allies are all necessary for a smooth landing.
The practice of growing budget deficits to keep the economy afloat has not stopped, despite the shift in the political landscape from democratisation to the return of authoritarianism. The power-sharing government that came to office during the 2011 revolt initially sought to increase fiscal expenditures.
In 2020, the pandemic marked a turning point in Tunisia’s public finance management as the budget deficit soared to 9.4% of GDP. Saied’s tenure in office, particularly following the July 2021 “political coup,” has increased unsustainability, even though swift action was required to reverse a trajectory that was headed toward financial collapse. In fact, the budget deficit has been about 8% of GDP for the last three years.
Saied alone is accountable for an economic strategy that has renounced all semblance of budgetary discipline since he gave himself complete authority. Even at the expense of losing almost all of Tunisia’s conventional funding sources, he has chosen to split from the IMF and has turned to monetising a sizable portion of the fiscal deficit, which could hasten inflation.
This circumstance also raises concerns regarding Tunisia’s public debt prospects, both in the short and medium terms. The future course of the public debt is still unclear at this point. The most recent IMF prediction from April 2024 does not anticipate a return to strong growth.
In 2024 and 2025, the IMF projects GDP growth to be 1.8% and 1.9%, respectively. This increase is significantly less than the low growth of 2.7% in 2021–2023. Additionally, the IMF predicts that while fiscal expenditures as a percentage of GDP would decline, state income will continue to rise in 2024–2025.
This outlook is a moderately optimistic scenario since it would allow Tunisia to stabilise its public debt at less than 80% of GDP by 2025 by gradually reducing its budget deficit.
Although the Tunisian Ministry of Finance envisions a similar scenario, it predicts a slower rate of increase in budget revenues in 2024–2026 (7.4%).
If it weren’t for domestic political restrictions, mainly due to Saied’s resistance to structural changes like reducing subsidies, turning to the IMF, and privatising public firms, both scenarios could be considered probable. The state finds it challenging to make significant changes, especially in the short term, as a result of these policies and the high rate of 11.2% growth in fiscal expenditures between 2021 and 2023.
The currency rate’s behaviour is a key factor in determining future possibilities. The decline in foreign exchange reserves, the decline in public accounts, and the government’s refusal to reestablish communication with the IMF all weakened the Tunisian dinar’s strength in 2023.
Since 2019, the prohibition on the dinar’s floating has led to an estimated 40% increase in the real exchange rate. The increase is because of the combination of inflation from the eurozone and cumulative inflation since 2019, which has resulted in an overvaluation of the dinar in relation to the euro. This implies that a significant adjustment is likely to occur at some point, as was the case in Egypt recently after the 2024 devaluation.
If devaluation occurs in Tunisia, it would result in a steep decline in real wages, a spike in inflation, and a rise in the domestic cost of repaying external debt, all of which would present difficult adjustment issues. Furthermore, one would anticipate that balance sheet implications would harm the financial sector in the event of devaluation.
First, the state’s foreign exchange loans would skyrocket, raising the risk to its sovereignty. Second, because SOEs are exposed to both domestic and foreign debt, the number of non-performing loans (NPLs) to public-sector businesses would also increase. According to the most recent report on public enterprises, the primary public firms’ debt has reached $7.2 billion (annexed to the budget legislation 2023). Tunisian banks provided $2.6 billion of this debt, with international banks providing the remaining amount.
Analysts are still baffled by the recent handling of foreign exchange reserves. The reserves have varied over the last three years, indicating that the Central Bank has profited from external deposits at different points. The amount, time, or expense of these procedures, as well as the deadline for repayment, are not specified, though.
Foreign currency reserves have been depleted more recently due to the cessation of external financing; they have decreased from 150 days of imports in July 2021 to 125 days of imports during the first nine months of 2022 and 92 days during the same period in 2023.
Furthermore, there is much ambiguity about the number of usable reserves and net reserves at the Central Bank, even if the gross reserves officially stood at $7.4 billion in February 2024. As was evident when the Central Bank had to pay 850 million euros on a Eurobond that matured in February 2024, it must now rely increasingly on foreign exchange reserves to handle the increasing servicing of the external debt.
As Tunisia nears a repayment milestone of several years, the debt service burden will only escalate. In 2024 alone, it will consume nearly all tourist income and diaspora payments. In the end, the stability of the dinar is at risk due to limited access to foreign credits, which could cause it to decline significantly in the upcoming months. Since the end of 2022, the central bank has maintained its key rate at 8% to implement an accommodating monetary policy.
The real interest rate, however, is marginally negative. This is not helping domestic savings, which have dropped to a historically low 8% of GDP due primarily to income losses. Short-term remittances could be pushed downward by the growing likelihood of a dinar devaluation, a step linked to low interest rates, as Tunisians living overseas either wait for a devaluation before sending money home or deal in an unofficial, parallel market. These actions might then trigger a run on reserves, which would eventually result in a steep devaluation and start a downward trend.
Allowing such an event to occur would put Tunisia in a financial crisis from which it would be impossible to recover. But, Lebanon’s experience serves as an extreme example of what might happen if unfavourable expectations are not promptly addressed.
It will be very difficult to finance both domestic and external deficits in the coming days. There is a significant financial deficit because just $1.5 billion of the $5 billion needed for 2024 has been raised externally. On the domestic front, the substantial planned borrowing will maintain inflation while also pushing out the private sector.
An increase in inflation could be the primary threat to the current financial system. In the end, inflation causes devaluation, which raises the cost of repaying the external debt. Increased foreign cash shortages would pose a greater threat to the system as a whole, increasing the likelihood of a run on reserves and, given their significant exposure to public debt, a run on banks as well.
Due to these circumstances, Tunisia is susceptible to even the smallest shock, whether it comes from within or beyond. Only in the very short run is the current state of affairs sustainable.
A significant investment drive would theoretically help Tunisia pay off its debt, but doing so would necessitate a significant shift in internal policies as well as a substantial package of assistance from foreign allies.
In 2025 and beyond, Tunisia will be increasingly likely to be forced to choose between two unpleasant options: restructuring its debt or pursuing austerity with IMF assistance.