Current Account Balance and Financial Development in MENA Countries: The Role of Institutions

Abstract

This paper examines the relationship between current account and financial development, while taking into account institutional quality in the Middle East and North Africa (MENA) region over the period 1990–2018. By applying various measures of the quality of institutions and two indices representing financial development, we found that, while most financial development indices have a significant positive effect on the current account, the coefficients of the interaction term are significantly negative. This clearly shows that institutional quality mitigates the positive effect of financial development on the current account. Our empirical results allow us to conclude that the level of financial development in a country with a high level of corruption increases the current account deficit. These results suggest that, in order to benefit from financial development, financial systems in MENA countries must be embedded within a sound institutional framework.

Appendix

Country List (12 Arab Countries)

Algeria, Bahrain, Egypt, Iran, Iraq, Jordan, Kuwait, Morocco, Qatar, Saudi Arabia, Tunisia, UAE.

See Tables 7 and 8.

Table 7 Correlation matrix

Table 8 Variables description and data source

Determinants of the Current Account Balance

Current account balance: the current account balance of a country over a given period corresponds to the sum of its trade balance, that is to say of the monetary flows resulting from the trade of goods and services of this country with abroad, of its balance of income and its balance of current transfers. In addition, it is considered that a current account in excess allows residents of the country concerned to repay their debts or lend to residents of other countries, and that a current account deficit is compensated by residents by taking out loans in other countries. other countries, by liquidating net foreign assets there, or by making profits thanks to the valuation effect linked to their net foreign assets.

Economic growth: Economic growth is often identified as an underlying determinant of the current account. Countries with high productivity growth can attract international capital flows because they are expected to generate higher rates of return. indeed, the growth of real GDP per capita is used as an indicator of productivity growth.

Fiscal balance: The link between the current account and fiscal balances is generally positive, which leads to the well-known “double deficit” hypothesis. This positive relationship is consistent with the predictions of several theoretical models. The finite horizon model of Blanchard and Watson (1984) and the overlapping generation models (Obstfeld and Rogoff 1995) indicate that a deterioration in the fiscal balance tends to have the same negative effect on the current account balance in to the extent that it implies a redistribution of income from future generations to present generations.

Oil intensity: The effect of oil price fluctuations on current account depends on several factors. Most importantly is whether a country is a net exporter or a net importer of oil. The size of the impact would then vary with how intensively a nation uses oil in its economy (for an importer), or with the relative importance of oil production in its economy (for an exporter).

Terms of trade: Terms of trade is a macroeconomic policy choice that may impact of current account, a more open economy being more vulnerable to external shocks. He measures the exchange rate of one product against another when two countries trade. This vulnerability is greater when trade flows are not diversified (Milesi-Ferretti and Razin 1996). In this respect, it could also be correlated with other factors that make a country attractive to foreign capital (Bussière et al. 2010). Thus, the sign associated with this variable can only be determined empirically.

Net foreign assets to GDP ratio: The transfer of savings from some emerging economies to the international capital market reflects the accumulation of official foreign exchange reserves under a fixed exchange rate policy. In particular, several emerging Asian countries have built large foreign exchange reserves since the Asian currency crisis of the late-1990s, in order to promote export-led growth by limiting real exchange rate appreciation, as well as to insure against future balance-of-payments crises. A country’s net foreign asset (NFA) position has a direct impact on its net investment income and, therefore, on changes in the current account. However, since the stock of NFA is determined by the sum of past current account balances, only the initial (lagged) stock level is included.

Foreign direct investment (FDI): As FDI is likely to have an impact on national investment and savings, it is intimately linked to the current account. Fry (1993) studies the impact of FDI on domestic investment and savings and deduces its influence on the current account for a set of developing countries. The link between the current account and FDI should be negative if the latter contributes more to strengthening domestic investment than domestic savings and vice versa.

Mork's Asymmetric Approach (1989)

Mork (1989) was the first to test the asymmetry of oil prices, and to propose a method to calculate the new variables. He starts from the observation that the significant relationship between oil prices and macroeconomic variables presented by Hamilton (1983) corresponds to a period of rising oil prices and that the sharp drops in these prices from 1985 to 1986 did not have an impact. proportional effect on macroeconomic aggregates as in the case of price increases. Therefore, Mork (1989) assumes that the impact of changes in oil prices on these aggregates cannot be symmetrical and proposes two new measures. The change in oil prices defined by Mork (1989) as follows:

The measure of price increases (MORK INCREASES) is given by:

$$Poil_{t}^{ + } = \Delta oil_{t}^{ + } = \max \left( {0,\Delta oil_{t} } \right)$$

The measure of price decreases (MORK DECREASES) is given by:

$$Noil_{t}^{ - } = \Delta oil_{t}^{ - } = \min \left( {0,\Delta oil_{t} } \right)$$

As $\Delta oil_{t}$ represents changes in real oil prices, and $Poil_{t}^{ + }$ and $Poil_{t}^{ - }$ are the positive and negative parts of changes in the real price of oil, respectively.

$$Poil_{t}^{ + } = \left\{ {\begin{array}{*{20}l} {oil_{t} {\text{si }}oil_{t} > 0} \hfill & {} \hfill \\ 0 \hfill & {sinon} \hfill \\ \end{array} } \right.$$

$$Noil_{t}^{ + } = \left\{ {\begin{array}{*{20}l} {oil_{t} {\text{si }}oil_{t} < 0} \hfill & {} \hfill \\ 0 \hfill & {sinon} \hfill \\ \end{array} } \right.$$

$Poil_{t}^{ + }$: presents the increase in the oil price

$Noil_{t}^{ - }$: presents the decrease in the oil price