Withdrawal of investment code legislation will hinder and delay Tunisian ambitions to improve access to international capital

Tunisia's authorities have withdrawn draft legislation to reform the investment code (the 'Code'), which is an important component of Tunisia's International Monetary Fund (IMF) lending program designed to attract greater foreign direct investment (FDI) inflows and boost economic growth. Opposition from within Tunisia's National Constituent Assembly within the context of increased rhetoric over economic resource nationalism has forced the withdrawal of the draft bill to revise the Code.

Tunisia on 12-13 June held its major annual conference for potential investors in Tunis. The Tunisia Investment Forum 2014 was presented as an opportunity to highlight a more transparent and healthy business environment under the new democracy, along with national consensus in key areas. However, we assess this to be over-optimistic in several respects, notably the working of the economy and the legal framework for potential investment.

Tunisia's dual challenge is to stabilise the macroeconomic environment while laying the foundation for more broad-based, inclusive growth in the future. Since the toppling of former President Zine al-Abedine Ben Ali in January 2011 Tunisia's economy has struggled with significant fiscal and external vulnerabilities, as well as high unemployment and elevated inflation. Revenue from phosphates mining, energy and tourism, have yet to regain Ben Ali era levels. Contributing factors have included protracted political deadlocks, the emergence of Salafist militancy in the country (including the first suicide bombing against a tourist resort in Sousse in October 2013) and unrest both by unionised workers and unemployed individuals in the interior of the country. In recent months, the country's foreign reserves have declined, but still have remained just above the critical three months' worth of imports benchmark (currently foreign reserves stand at 3.2 months).

Tunisia's interim technocrat government is keen to engage in economic reform to restore international credibility and confidence, thereby attracting foreign investment and improving access to international capital markets. Key to this is a proposed revised Investment Code, first presented as a draft in March 2013. The Bill was largely drafted by a panel setup by the International Financial Corporation, which extended Tunisia a EUR650,000 (USD880,000) grant to assist development and adoption of the Code.

The Code is intended to offer greater transparency and more attractive incentives for investors than had existed in the Ben Ali era, when sectors such as automotive sales, telecoms and logistics were effectively barred to foreign investors unless they entered partnership with Ben Ali affiliated companies owned by his relatives and political allies. However, it has proved controversial within the National Constituent Assembly, Tunisia's interim parliament, which needs to approve it before its passage into law. A new measure to allow foreigners to acquire agricultural land, intended to boost agricultural FDI beyond its historical average of less than USD10 million, has been particularly strongly opposed by the leftist CPR party, already pushing a resource nationalist narrative in the energy sector. As a result, Economy Minister Hakim Ben Hammouda was forced to withdraw the draft legislation in May 2014.

Tunisia has already delayed the implementation of several reforms agreed with the IMF, with four out of eight benchmarks scheduled to be completed by March 2014 yet to be finished. Key reforms not yet complete include a targeted household support program to accompany a planned reduction in energy and food subsidies, revisions to the investment code, restructuring and potential privatisation of state-owned commercial banks, and creation of an Asset Management Company (AMC) to deal with non-performing loans in the tourism sector. Economy Minister Hammouda has delayed the adoption of these reforms by issuing last-minute counter-proposals aimed at, respectively, narrowing or extending the scope of the bank privatisations and AMC projects.

The IMF has been fairly flexible in regards to missed deadlines for structural reform benchmarks under Tunisia's lending programme. Nevertheless, theoretically, failure to push through revisions to the Code could threaten close to USD1.16 billion (USD660 million from the IMF, USD500 million from World Bank) in conditional budgetary support planned for the remainder of 2014. However, although the postponement of revisions to the Code is a setback, the IMF may grant a waiver in light of ongoing progress on other reforms related to fiscal, financial, and monetary governance. The World Bank has pulled back funding in the past because of failed progress on reforms, though it remains unclear whether the withdrawal of the revised Code would trigger such action.

Outlook and implications

The withdrawal of revisions to the investment code will probably have limited financial effects in the near term, though if completed it would be a welcome boost to investment and growth. Tunisian central government debt is manageable in the near term at 52% of GDP, and the Tunisian government maintains access to both foreign and domestic capital markets (sovereign bond yields and credit default swap spreads indicate healthy financial market sentiment at present). IHS expects Tunisia to be able to muddle through 2014, meeting its financing needs barring any unexpected political/security shocks as was the case last year – such shocks could include the emergence of a coordinated terrorist campaign against tourism, for instance, or further political assassinations. However, in the event of such shocks, neighbouring Algeria (which does not wish to find another failed state such as Libya on its doorstep) would probably step up financial aid to Tunisia to shore up the government's position.

Any legislative action or movement on the investment code will likely be delayed until after national elections provisionally set for 26 October. Economy Minister Hakim Ben Hammouda expressed hope that the next government would be able to prepare new plans to reactivate investment, in a tacit acknowledgement that the Code was unlikely to be passed by the current interim government. However, any new government is still likely to have to contend with a strong resource nationalist trend within the new parliament, together with resistance to reforms such as privatisation from Tunisia's unions and most particularly the powerful General Tunisian Workers' Union (Union Générale Tunisienne du Travail: UGTT), which have the power to mobilise nationwide strikes.

Ultimately, however, there is a high probability that the civil service, which has worked with the IMF for years before the overthrow of Ben Ali and which has mostly survived the upheaval, would in the end succeed in getting politicians within the new government and parliament to agree the reforms. The key indicator would be the strength of the alliance between political parties that win the upcoming elections and Tunisia's powerful unions. A strong showing by parties allied to labour unions would likely lead to further revisions of codes and watering down of reforms.

In the case of a fiscal crunch in the absence of financing, Tunisian authorities would likely delay payments to public enterprises first, followed by postponements to capital expenditures, just as the government did in 2013 when financial commitments came up short. Low foreign reserves remain a concern, but international donors continue to backstop Tunisian authorities through foreign aid, loans, and deposits at the central bank. Foreign reserve levels have edged down to USD7.1 billion through the first five months of 2014. That said, May 2014 reserves levels were about 5% higher than a year ago. Nevertheless, the currency could come under some pressure should reserves deteriorate, though it is likely that Tunisia authorities would be willing to tolerate a slightly weaker dinar in the absence of foreign reserve interventions.