The adverse effects of inflation are particularly harsh on the economy of South Mediterranean oil importers. Because of the Russian war against Ukraine, the price of food and energy products has increased more than that of other goods, which has impacted on the cost of living of less affluent households. Although the Black Sea Grain Initiative has facilitated the exports of food and agricultural products from Ukraine since August 2022, the context ¶{p. 86}remains highly uncertain. Hence, inflation risks exacerbating inequality, which was already on the rise because of the effect of the pandemic almost everywhere. Indeed, nominal wages tend to adjust more slowly than the increase in prices and, as a result, the real wage has decreased almost everywhere, reducing the ability of households to maintain their living standards.

As already stressed, the recent rise in inflation is rooted in both supply and demand factors. Yet in some South Mediterranean countries financial and political instability has played a major role in causing inflation in the past. High levels of public debt or political instability reduce international investor confidence and may lead to currency depreciation. In turn, currency depreciation increases the cost of imported goods and services, thereby pushing up internal prices. Low productivity is yet another factor that can contribute to inflation. When productivity is low, firms may have to raise prices to maintain their profit margins, leading to an increase in the general price level of goods and services.

Here are some examples of how political and economic strains have impacted exchange rates among South Med countries. A sluggish economic recovery, the international shocks on the balance of trade, a very fragile financial equilibrium and, most of all, political uncertainty have caused the Tunisian Dinar to depreciate by 8 per cent from a year earlier against the US dollar and caused the sovereign spread vis-à-vis the United States to widen by 16 percentage points in December 2022. In Egypt, as well, sovereign spreads have widened because of the pressures from rising food and energy prices. The spreads have almost doubled in the last two years and reached 8 percentage points. Morocco saw the dirham depreciate by almost 6 per cent against the US dollar and the euro in the second half of 2022.



Following the halt in 2020 because of the pandemic, global trade resumed at a significant rate in 2021 up to mid 2022. In the second half of the year, however, global trade decelerated: the reduction in economic activity in the major economies, the increase in transportation costs, the rise in energy prices and increasing uncertainty are all factors that have applied downward pressure ¶{p. 87}on the exchange of goods and services between economies. Med countries have followed the same pattern, with slight differences mainly between oil-exporting and oil-importing countries. The growth slowdown in the European Union and the corresponding contraction in imports have negatively affected South Med oil-importing economies: exports of these economies depend to a great extent on the European market (about half of the exports in 2021 corresponding to 7.4 per cent of GDP) and a recession in Europe would also endanger their expected growth. The context could further deteriorate if the slowdown of economic activity comes with a prolonged increase in energy prices and travel costs. Dangerous stagflation would indeed hit mainly the tourism sector on which many small economies rely. For instance, in Jordan and Lebanon inbound tourism expenditure averaged 6 per cent of GDP in 2019.

Almost all countries in the Mediterranean run large current account deficits, signalling a strong dependence on imports (see fig. 7). This dependency increased after the pandemic shock and the outbreak of war in Ukraine. Small economies are particularly vulnerable to global economic slowdown and to inflation shock. For instance, Albania, Serbia, Cyprus, Montenegro, Tunisia, the West Bank and Gaza ran up current account deficits between 9 and 13 per cent of GDP in 2022.

Thus a very large fraction of these economies depend on external influences. The only countries that register current account surpluses in the area are the oil exporters Algeria and Libya. Yet the surplus in both cases is expected to shrink following the reduction in oil and gas prices in the second half of 2022.

The pandemic and then the Russia-Ukraine war have put considerable pressure on global supply chains. Following the fall of the Berlin Wall in 1989, the world has experienced a long period of globalization during which firms have relocated their production worldwide, seeking ever lower costs of production and greater efficiency. Global supply chains have stretched considerably, as have global trade and interconnections between countries. The recent halt due to the pandemic, but most of all the Russian War on Ukraine, have abruptly changed the international context by forcing most countries to reduce the rate of external dependency especially on the energy side and on key production factors such as some metals, and some intermediate ¶{p. 88}factors of production such as electronic chips. This reshaping of international trade and the global value chain will have a large impact on the Mediterranean area by increasing dependency between the northern and southern shores.