Over the past decade and a half, Tunisia has won plaudits for its gradual macroeconomic reforms and stable monetary policy. The IMF recently noted that ?Tunisia's economic performance has been one of the strongest in the region? over the past 10 years. It is one of only three African countries carrying an investment-grade rating ? BBB with a stable outlook from all leading agencies.
According to the IMF: ?Fiscal and monetary discipline has contributed to macroeconomic stability, in the context of a real effective exchange rate targeting framework with controls on capital flows.? Rather than allow the market to determine the exchange rate, Tunisia's central bank aims to maintain a stable real rate against a basket of currencies weighted to take account of major trading partners and competitors.
The absence of a fully convertible dinar has become problematic for Tunisia, despite the benefits it has brought. Nick Eisinger, director of sovereigns at Fitch Ratings, says: ?Capital account liberalization is necessary if Tunisia wants to be more integrated into the global financial system and open itself up to a larger base of foreign investors.?
The IMF wants the authorities to relax capital controls to diversify external financing sources and maximize the benefits of foreign capital for investment and growth. Tunisia has also been advised to take steps to deepen the foreign exchange market, with the objective of moving to a floating rate.
Long-serving president Zine al-Abdine Ben Ali has raised hopes of reform via recent comments about the need for a modern banking and financial system, and the possibility of a fully convertible dinar. Ezzedine Saidane, a financial consultant and vice-president of the Tunisian American Chamber of Commerce, believes that in the next four years the authorities will further free up the exchange rate regime. The deadline is likely to be 2008, in line with a commitment to remove capital controls in compliance with a European Union association agreement.
Steps have already been taken. Nabil Khemiri, vice-president for regional sales and trading at Citigroup in Tunisia, notes: ?The dinar is currently convertible for trade, for all financial and commercial transactions, and for all investment transactions.? Thus, says Saidane, the dinar is in practice fully convertible for non-residents. Foreigners can freely invest in the country and take their money out when they sell their investments.
More recent reform measures have involved the authorities reducing surrender requirement and abolishing the need for banks to transfer foreign currency balances to the central bank daily. Khemiri notes that the authorities are allowing repo on government securities, which will aid the development of a secondary market in government bills and help improve banks' day-to-day liquidity. The IMF has praised progress towards developing a monetary framework aimed at price stability, but would like to see an end to the central bank's posting of bid-ask spreads for the exchange rate.
When considering capital account liberalization, the authorities must determine whether the benefits of a free exchange rate outweigh negatives. Eisinger believes that when the central bank stops trying to manage the exchange rate directly, integration with the world economy will be encouraged and time and money will be saved.
FDI effects
The likely benefits to foreign direct investment flows are less apparent. Khemiri says: ?Financial studies have shown that when currencies become fully convertible, FDI inflows increase?. However, Saidane considers that deregulation would offer a psychological boost to investors while not fundamentally altering their business decisions. In the worst circumstances, says Eisinger, liberalization accompanied by currency volatility could have a negative impact on FDI.
The risks involved in freeing the exchange rate are linked to weaknesses in Tunisia's macroeconomic fundamentals. The IMF has stressed ?the need to lay the groundwork for such a transition by strengthening the banking sector, reducing public debt, and deepening the development of money and foreign exchange markets.? Eisinger believes that capital account liberalization will encourage non-residents to purchase dinar-denominated government debt, and will reduce the authorities' ability to control the level of external debt. Thus deregulation, he argues, ?will definitely lead to more volatility in Tunisia's foreign exchange market?.
Uncompetitive Tunisian companies could also suffer, and Saidane says banking sector reform is particularly urgent. The sector's problems include a high, and rising, rate of non-performing loans (currently about 23%); banks' poor ratios of operating charges to net income (averaging 60% to 70%); a lack of qualified staff; expensive and inefficient IT systems; and a judicial system that hinders banks' ability to chase up bad debts.
Tunisia's journey towards a free exchange rate must therefore encompass financial sector reform in parallel with increasing deregulation. Saidane argues that ?the full convertibility of the dinar should be considered a tool and not an objective in itself?. Tunisia, he says, can only make use of this tool if the economy is sufficiently strong. Eisinger similarly stresses the importance of getting the sequencing right, and argues that ?If the authorities get things right, the practical implications of capital account liberalization will be relatively limited. If things go wrong, there will be serious implications.?
Observers should take heart from the fact that gradual reform with an eye to economic stability has long been the central bank's style.