Euromoney: Tunisia Faces Pain Before Reward

Euromoney, February 2015

The World Bank reports that banks need profound reform; analysts catalogue a long list of problems; and the country hasn’t even formed its cabinet yet. Can the new president juggle competing political factions and unblock the economic pipeline to bring badly needed growth quick enough?

In December 2010, the events we now call the Arab Spring began in the town of Sidi Bouzid, Tunisia. Beginning with the self-immolation of a young street vendor in protest at his treatment by a municipal officer, the subsequent demonstrations and riots would be felt far beyond that town, leading to regime change in some countries, civil war in others. Looking back, the only place that can claim to have had the peaceful transition to democracy that protestors would have hoped for is the place where it all began: Tunisia.

In December, Tunisia held a presidential election without unrest, following a parliamentary election, also mostly peaceful. So can we call the Arab Spring a success in Tunisia at least? Politically and socially, perhaps, but Tunisia’s economy remains in a dreary state, sluggish and in need of reform. And few things illustrate this more clearly than the banking sector.

“Following the Arab Spring, numerous issues facing the banking system have surfaced,” says Olivier Panic, the lead analyst for Tunisia at Moody’s. He reels off a list. “Weak asset quality, inadequate provisioning, inefficient and undercapitalized public sector banks, inadequate pricing framework, very lengthy and unpredictable banking claim recovery process, and heightened funding and liquidity issues, with banks increasing their reliance on central bank funding.”

It’s quite a list: it’s hard to think of a mainstream banking grievance that isn’t on it. But it’s absolutely vital that Tunisia’s banks are turned around. Without their capacity to lend, the economy won’t start to grow in earnest; without growth, there won’t be employment, particularly among the young, which is arguably the single most pressing social issue in Tunisia today; and without employment, we could very well find ourselves back in a situation of frustration and anger that could take Tunisia back to the social unrest that was in evidence in 2010.

MOST METRICS SHOW A BLEAK
situation in Tunisian banking. Panic at Moody’s quotes nonperforming loans of 15%, but says they are worse still, 20% if loans transferred to bank-affiliated asset management companies are included. Provisioning, at 60%, is not really sufficient for NPLs at that sort of level, although Panic says they have improved following the implementation of a new regulation in 2013 on collateral haircuts, which imposed provisioning requirements on banks, particularly when they are exposed to real estate and tourism.

The Arab Spring has been, on the face of it, bad for bank performance in Tunisia: return on equity has dropped from 11.7% in 2009 to 8.1% in 2013. Nor is there enough capital: the tier-1 ratio was 7.7% in March 2014, and seven out of 21 banks in the country hold a total capital ratio below 9% (although three do appear to have been recapitalized since, with work underway on the others).

Then there’s the fact that there are 21 banks for a country with a population of 10.89 million and a GDP of $47.13 billion in 2013, ranking 83rd in the world on the IMF’s numbers, below Costa Rica, Burma and Slovenia. This wouldn’t be so bad if the 21 were in healthy competition, but that doesn’t appear to be the case (something the World Bank refers to as “the paradox of the Tunisian financial sector: many banks, but little competition”). And the country has other priorities than merging them. “We understand that banking sector consolidation, through the merger of public sector banks, is not on the government’s agenda,” says Standard & Poor’s.

Worse, they’re not really lending, and they struggle to do it when they can since there aren’t enough deposits to fund loan growth, with no real alternative in the local capital markets. The loan-to-deposit ratio stood at 113% in May 2014.

“Credit growth has significantly slowed down since 2011,” says Panic. “We view the credit conditions in Tunisia as relatively weak,” for several reasons: poor underwriting standards resulting in large portfolio concentrations in the sectors where collateral is available, chiefly real estate and tourism; the over-valuation of loan collateral, leading to under-provisioning; high single-borrower concentrations, a result of a small number of large industrial conglomerates in Tunisia; an inefficient recovery environment for banks; and a lending-rate cap mechanism that doesn’t really encourage banks to lend more. “These constraints, combined with limited liquidity availability, limit the lending capacity of Tunisian banks, especially to SMEs,” he says.

The World Bank’s benchmark report on Tunisia in September devoted a chapter to the financial system, and one gets a sense of the tone from its title: ‘A financial sector in disarray.’ It says the sector “suffers from deep dysfunctions and has been unable to channel resources towards the most productive activities and projects.”

Like the rating agencies, the bank believes there is limited ability to lend credit, and feels “the weak credit intermediation is a brake to economic performance in Tunisia.” It complains that, while ordinary businesses have struggled to gain access to finance, cronies have instead had easy access, “entrenching the misallocation of resources and contributing to the weak performance of the economy.”

STILL, IT’S NOT ALL BAD NEWS. THE optimistic view is that we are amid an inevitable slowdown at a time of necessary upheaval and that the new government appears committed to reform.

It’s because of the clear need for reform – and not just in banking – that these elections are so crucial, and here an understanding of the political dimension is important.

On December 22, Beji Caid Essebsi, the 88-year-old leader of Nidaa Tounes, which won 39% of the seats in the parliamentary elections, won a presidential run-off against the incumbent, Moncef Marzouki, the interim president. Essebsi – who has already been prime minister once, in 2011 – was always considered the front-runner, but the bigger question was: what sort of cabinet would he form (and, not to be indelicate, if he can live long enough to see it through a full term)?

“I hope, if there’s any political pragmatism – which Tunisia has shown a lot of – that he will include the various political groups that represent quite a large stake in Tunisia, including the moderate Islamists,” says Albert Arbuthnott, analyst at Salamanca Group, a London-based merchant bank and operational-risk management expert. “It will be very significant whether he is inclusive or marginalizes certain groups.”

Arbuthnott was speaking before January 23, when a cabinet was presented, and it did indeed prove to be significant. It included no members of the moderate Islamist Ennahda party, among others, and was promptly rejected by most of Tunisia’s political parties, who said they would oppose the line-up in parliament. At the time of writing, Tunisia’s prime minister-designate, Habib Essid, was believed to be in talks with Ennahda and other slighted parties about a potential compromise.

This matters because the cabinet that is eventually put together, reflecting these delicate and fractious ideological issues, will be the one that has to deal with all the urgent problems in the economy and financial system.

“Tunisians have a lot of very difficult decisions to make,” says Arbuthnott. “The system has to be reformed, including the archaic banking sector. It will take a lot of time before foreign direct investment is elevated to the extent that the average Tunisian feels the effects.

“Unemployment is running at about 30% in the youth of Tunisia, and as long as the country is in a bad state economically its political stability will be threatened,” he says. “In January, when we see what cabinet the winner brings together, we can begin to assess if it is able to undertake the necessary and unpopular reforms to bring Tunisia out of its economic slump.”

It’s not just about the banking – as in many other peers, such as Morocco, subsidy reform around energy and food is equally key – but the financial sector will be a big part of the reform that must take place.

It’s important to recognise that, even pre-election, efforts were made to improve things. “We acknowledge that the authorities have been addressing some of these issues,” says Panic. Apart from the new regulations around haircuts on collateral, higher prudential requirements have been put in place to push private-sector banks to recapitalize. He says that public banks, which represent 34% of banking assets and have been showing poor performance because of their exposure to real estate and tourism, should be recapitalized in the next few months.

There are also plans to implement an asset management company, a long-established method of dealing with bad-loan problems when a country emerges from crisis or unrest. And the central bank is trying to do its bit, tightening its collateral framework and establishing a lender-of-last-resort facility where necessary. That said, there’s more to do.

“Banking regulation and supervision remains weaker than international standards in our opinion,” says Mohamed Damak, credit analyst at Standard & Poor’s, in a recent report. He acknowledges the central bank’s efforts to strengthen the regulatory framework. “Nevertheless, we think that aligning Tunisian regulation with that of most advanced peers will take time.”

Damak also notes poor governance and weak transparency.

Also, while elections are clearly vital if the world is to see Tunisia’s revolution as any sort of success, there’s no denying the fact that they tend to put a lot of urgent work on hold, just as they do in western democracies.

“The recent elections have delayed, to some extent, the reform process,” says Panic. “For instance, the recapitalization of the public banks, although there seems to be a consensus that it will move forward, has been left to the vote of the new assembly, which will take place following the election of the new president.” And here’s an uncomfortable truth. “It is fair to say that we can usually expect reforms to be implemented at a slower pace by democratic regimes than authoritarian countries. However, the reforms tend to be much more sustainable.”

Naturally, what will really help banks is economic growth, though this is something of a chicken-and-egg situation since Tunisia needs the banks to drive the economy. Standard & Poor’s is expecting GDP growth of 2.8% in 2014, 3.5% in 2015 and 4.2% in 2016 if the political environment remains stable. Set against that modest growth is a troubling fiscal picture with a sharply widening current account deficit and increased use of external debt. Meanwhile real-estate prices have risen out of reach of many people, which doesn’t help concerns about inequality.

SO WHAT TO DO? THE WORLD Bank has what it believes is a clear roadmap for fixing the banking sector, with specific recommendations. It starts with restructuring of the state-owned banks, although it allows for a range of options as to how this should happen: merging the three main state-owned banks (Societe Tunisienne de Banque, Banque Nationale Agricole and Banque de l’Habitat, which between them account for 37% of banking sector assets),

or direct sale. “The government should revisit the rationale for being the ultimate owner of these three large public banks, which are essentially commercial, with limited activities formally conducted on behalf of the state,” the World Bank says. “It should also stop using state-owned banks to support (even temporarily) state-owned enterprises and entities.”

Corporate governance must improve too.

Next is regulation and supervision, not just of the banks themselves, but to foster a capital market with a usable yield curve. The World Bank wants bankruptcy laws reformed – this is already underway – and welcomes the establishment of an asset management company to resolve NPLs from tourism. It calculates that, if all bad assets from that sector are transferred, the overall NPL ratio should fall from 13.5% (that’s the World Bank’s calculation of the current level, which is lower than some rating agencies think) to 10.25%.

“A series of profound reforms are needed in the financial sector,” says the World Bank. But it’s well worth doing. The bank says the reform of bankruptcy procedures alone could achieve additional investments of $2.1 billion, corresponding to approximately 80,000 new jobs. And if the share of credit to GDP were to grow from 70% today to its potential of between 80% and 90% as a consequence of financial reform, the bank says that could generate more than $10 billion that could be injected back into the economy to finance private investment. That, the bank says, would equate to an additional 380,000 jobs.

If that happens, then any threat of social unrest is immediately undercut by the fact that ordinary Tunisians can see, in the job market, tangible evidence of improvement. But it requires a strong government to see it through.

“Reform, and subsidy reform in particular, does produce unrest,” says Arbuthnott. “The economy in Tunisia is not in a great state as it is, and reform will at first increase the burdens on the public, though it will create a better future in the long term.”

There is a lot at stake. That’s why Tunisia’s bankers, as much as the broader population and anxious observers, will be watching the cabinet that will be presented to parliament any day now with keen interest.

BOX

Anyone who flies in to Tunisia sees one thing first: the coast, long and sinuous, where the desert meets the blue of the Mediterranean. Coupled with its (until recently) political stability and its proximity to Europe, it seems a natural place to build a tourism sector. And that is what Tunisia tried to do through the 1980s and 1990s.

It was at first successful, building beach resorts targeted at European holidaymakers. Hotel space tripled and tourism revenue grew 20 times over during those two decades, to the point that by 2010, tourism accounted for 7% of GDP, 14% of jobs and over 10% of total exports, making it a vital earner of foreign exchange.

Then things started to go wrong. The low-cost, all-inclusive holiday market the Tunisians had gone for became saturated, and after a while there were just too many beds for demand. Occupancy, rates and revenue dropped. Travellers became nervous about Muslim countries after 2001, particularly after a bombing within Tunisia at Djerba in April 2002. And with the sector’s decline came a glut of non-performing loans. By the end of 2010, according to the World Bank, outstanding credit to the sector was equivalent to 6% of GDP, and bad loans in the tourism sector to 2.5% of GDP, “and this figure may significantly understate the problem,” the World Bank says in its report. “State-owned banks are by far the largest providers of credit to the tourism industry, but the problem is widespread with 15 out of the 21 commercial banks operating in Tunisia exposed to the tourism sector.”

Revolution didn’t help: it is thought tourism revenues declined 40% in 2011 alone. The World Bank believes that one third of Tunisia’s 850 hotels went into severe financial distress in 2011.

Unless there is a rapid revival in foreign holidaymaker interest in Tunisia, tourism NPLs are only going to get worse as these numbers feed through.