Tunisia’s tough decisions: to reform or face debt default

• Tunisian external debt is $43bn
• Budget deficit 7.6% of GDP
• Default averted by foreign loans

As Tunisia’s president Kais Saied celebrates his re-election, the former lawyer must decide whether to implement unpopular reforms to receive a foreign bailout or risk the North African country making its first ever debt default.

Tunisia was close to reneging on some of its borrowings late last year and again earlier this year, but averted doing so after Saudi Arabia provided $500 million in a soft loan and grant, the African Development Bank (AfDB) approved a €92 million ($103 million) support package, and Italy lent €50 million.

Tunisia’s gross external debt swelled to 129.3 billion Tunisian dinars ($42.7 billion) at the end of 2023, the most recent central bank data shows, more than doubling since mid-2016.

The country’s budget deficit rose to 7.55 percent of gross domestic product (GDP) in 2023 – the second worst in the Middle East and North Africa after conflict-plagued Syria, according to S&P Global – as it sought to quell unrest through state largesse. 

The International Monetary Fund (IMF) provisionally agreed to lend Tunisia nearly $2 billion in 2022 but this deal was never ratified amid bellicose rhetoric from Saied against the organisation.

The European Union is Tunisia’s biggest trading partner. In 2022, 70 percent – or €12.5 billion ($13.7 billion) – of Tunisia’s exports went to the EU and 46 percent (€13.5 billion) of its imports were from the 27-member bloc. 

The EU is a major donor, pledging €600 million in grants to Tunisia for the period 2021-24. It previously gave €1.6 billion in 2014-2020. The bloc also provided a further €255 million to support Tunisia’s efforts to thwart people smuggling and human trafficking.

“Any additional funding from the EU is likely to be contingent on Tunisia agreeing to an IMF programme and implementing necessary economic reforms,” says Tunisia-born Rym Ayadi, founder and president of the Euro-Mediterranean Economists Association, who estimates the country has around $4 billion to pay in debt servicing this year alone.

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Last year, nearly 158,000 people entered the EU as irregular migrants via the so-called central route from North Africa’s northern coast to Italy and Malta, up 49 percent versus 2022. Tunisia was the most used departure country within the central route, while Libya was second, EU data shows.

“The EU may offer further support to help Tunisia avoid a default, especially given concerns over regional stability and migration,” says Ayadi.

Required reforms include so-called fiscal consolidation – which involves reducing state debts and deficits – and subsidy cuts, she says.

Yet Saied’s opposition to what he views as “foreign diktats” could lead to a stalemate if the EU’s conditions are too stringent for him, Ayadi warns.

“An EU bailout without an IMF programme is unlikely, as the EU generally prefers to work in tandem with international financial institutions,” says Ayadi.

“The EU’s primary role might be to supplement an IMF-led effort rather than act as the sole financier. Additionally, the EU is concerned about the precedent that unconditional aid might set, potentially encouraging other countries in the region to 'weaponise' migration flows for financial gain.”

Fitch downgrade

Fitch Ratings in June downgraded Tunisia to CCC+, which indicates “default is a real possibility”.

The country's debt repayments equated to 3.2 percent of GDP in 2022, the highest level since 1997. The central bank has adopted unorthodox practices such as spending foreign exchange reserves on debt repayments.

Although the central bank does not disclose its interventions in foreign exchange markets, the dinar’s stability over the past two years indicates it has also been using foreign reserves to prop up Tunisia’s currency.

Eroding the reserves makes the central bank less able to support the dinar; were the dinar to fall in value, the cost of repaying foreign currency loans would rise and so increase the likelihood of default. 

In 2021, the IMF warned the dinar was 5-10 percent overvalued and is likely to be significantly more overvalued now. 

A default could trigger a banking crisis, warns Ayadi.

“That could lead to further capital controls to prevent capital flight, which in turn would cause the dinar to collapse,” she adds. “This would be the beginning of a serious economic crisis and social unrest.”

Reforms required

For Tunisia to reduce its budget deficit and get its debts under control it must undertake other reforms that will be unpopular with ordinary citizens. These include reducing the workforce in its bloated public sector and privatising – or least reorganising – loss-making state-owned entities such as Tunisair and milling company Office des Céréales.

Yet introducing these reforms is especially difficult when economic growth is sluggish – Tunisia’s real GDP expanded just 0.04 percent in 2023, while annual inflation was 9.3 percent, S&P Global estimates.

The country may also seek to restructure its debts – extending maturities and obtaining better terms – to give it more breathing space to enact reforms.