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Tunisia : the inflation trap 5/9/2019

Inflation reached in 2018 all-time high, at more than 7%. Consequently, the central bank tightened its monetary policy. But weaknesses of the banking system limit the room for manoeuvre while persisting downward pressures of the dinar against the euro should continue to fuel inflation in coming months.

TRANSCRIPT // Tunisia : the inflation trap : May 2019

THE CHART OF THE MONTH

François Doux: In the Chart of the Month for May 2019, we’ll be looking at the Tunisian economy. Things improved in 2018, with growth of 2.5%, thanks to the recovery in tourism activity.

Be careful when we look at 2019, however; the IMF has recently cut its forecasts. Instead of 3%, it now expects GDP growth of just 2.7% in 2019 in Tunisia. Stéphane Alby, hello.

Stéphane Alby: Hello.

François Doux: Stéphane, there is fragility in the Tunisian economy, particularly when it comes to inflation. This is the subject of this graph; we can see the blue line, the left-hand scale. Why did you choose inflation?

Stéphane Alby: For two main reasons. First, because of its scale. As you can see on the chart, inflation rose from 3% in 2016 to over 7% in 2018, a level that it had not previously reached since 2000.

And then there is the duration of the phenomenon. Of course, we have seen surges in inflation before. In 2013 for example, inflation peaked at over 6% in the second quarter, but it slowed down rapidly after that. This was not the case in 2018, with inflation remaining stable at around 7.5% throughout the year.

François Doux: Tell us more about the consequences of this very high inflation on the economy.

Stéphane Alby: There are many effects, starting with the erosion of consumer spending power. Until recently, households’ consumption has been keeping the Tunisian economy afloat, but there are fears that this engine may have seized up in 2018. The upsurge in inflation also pushed the central bank to raise its rate by a total of 275 basis points in three steps during 2018, thus accentuating the pressure on the banking system which has become increasingly dependent on liquidity provided by the monetary authorities.

François Doux: We can see the bank’s policy rate in the yellow line, again using the left-hand scale of the graph. The IMF has long been critical of the Central Bank of Tunisia for not doing enough to tackle inflation, but following these recent rate rises, real interest rates have become positive again. Does this mean that inflation is likely to calm down over the next few months?

Stéphane Alby: The tightening of monetary policy is a necessary condition, but on its own is not sufficient. One of the sources of Tunisian inflation is external. The dinar has lost more than 30% of its value against the euro since 2016, with the prices of imported goods rising as a result. External imbalances remain significant. Currency reserves have fallen to less than three months’ worth of imports of goods and services. Everything suggests that the dinar will remain under pressure over the coming months. In other words, inflation is likely to stay high in the short term.

François Doux: So, in conclusion, should we expect further steps from the Central Bank of Tunisia in 2019?

Stéphane Alby: It’s likely, but given the fragility of the economy in general and the banking sector in particular, the monetary authorities have very little room for manoeuvre.

François Doux: Stéphane Alby, thank you. In a moment, three questions on France, with Hélène Baudchon.

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On the Same Theme

Tunisia: Sluggish economic growth 8/28/2019
The government’s 2019 budget growth target of 3.1% is clearly out of reach. Indeed, real GDP growth stood at only 1.1% during the first six months of the year. Except tourism and to a lesser extent agriculture, most sectors have stalled, or even contracted (industry). Headwinds will remain powerful in the coming months, starting with the subdued demand from European countries. Despite signs of inflation stabilization, the monetary environment will also remain restrictive amid strong pressure on external accounts. Above all, uncertainties linked to presidential and parliamentary elections scheduled in September-October will continue to weigh on the business climate and thus investment. The economic recovery expected in 2020 will greatly rely on a steadfast implementation of reforms. The task is huge.
Tunisia: The dinar under pressure 12/13/2017
The worsening of Tunisia’s external position is a source of concern. From 5% of GDP in 2010, the current account deficit has widened to 9% in 2016, and the situation deteriorated further during the first nine months of the year despite the rebound of tourism. Rising external imbalances put the exchange rate under pressure. The dinar has lost 25% of its value against the euro since 2016. The ability of the central bank to defend the currency is reducing more and more. Forex reserves felt to USD 5.6 bn in October, which is barely sufficient to cover 3 months of imports of goods and services. The weakening of Tunisia’s currency fuels inflationary pressures and weighs on the central government debt. In the meantime, exports gains are limited as the external competitiveness of the manufacturing sector erodes. Rebalancing external accounts could be difficult to reach without a contraction in FX reserves and a further depreciation of the dinar.

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