On the straight and narrow



Wed, 19 Apr 2017 - 01:53 GMT


Wed, 19 Apr 2017 - 01:53 GMT

Creative Commons

Creative Commons

Although International Monetary Fund officials have repeatedly welcomed Egypt’s commitment to the reform program, its formal mission for the program’s first review, scheduled for February-March, was delayed to the last week of April and consequently so was the disbursement of the loan’s second tranche, worth LE1.25 billion. “The IMF mission to Egypt has been delayed due to the authorities’ other commitments. The first review visit to Cairo is tentatively planned for April,” the IMF Mission Chief for Egypt, Chris Jarvis, tells bt, without disclosing any further details.

Finance Minister Amr El-Garhy cited the ministry’s tight agenda as the reason for the delay, as it has been fully dedicated to finalizing the new budget due for submission to the parliament before the end of March.

A team from the IMF had visited Cairo on January 30 to prepare for the first review, and Egypt’s Finance Minister met with IMF officials in London in March to discuss the reform progress as “part of the continuous dialogue between the authorities and the IMF and to prepare for the first review mission,” IMF spokesperson Randa El- Naggar tells bt. “The IMF mission conducting the first review will start the last week of April for about two weeks; exact dates will be announced closer to the visit,” she adds.

The IMF loan in context
Facing increasing and chronic economic troubles, Egypt’s authorities launched an ambitious reform program in November to reinstate macroeconomic stability and promote inclusive growth to revive an economy that has, since 2011, been hit by political instability and regional security concerns.

One key target of Egypt’s reform program is to restrain a high budget deficit and public debt, a goal that many governments have tried to achieve since President Abdel Fattah Al-Sisi’s inauguration in July 2014.

During the six years following the 2011 revolution, public debt leapt from 70% of GDP in 2009/2010 to 95% in 2015/16. The overall fiscal deficit also widened from 7% to 8% of GDP to 10% to 13%.

Many economists, therefore, cast doubt over the government’s ability to put this deficit under control with the public debt registering record levels and interest payments eating up more than one-third of the budget.

As a result of cutting the subsidy bill in the fiscal year 2014/15, the deficit dropped to 11.5% of GDP, from more than 13% in 2013/2014. Deficit then widened again in 2015/16 to reach 12.2%—compared to a planned 8.9%—as reform pace slowed down with the government postponing the capital gains’ tax and VAT and after another round of subsidy cuts.

“Reducing fiscal deficits considerably and thereby placing public debt on a clearly declining path is an important objective of the authorities’ program…The planned fiscal consolidation is projected to reduce public debt by almost 10 percentage points of GDP by the end of the program,” the International Monetary Fund’s (IMF) Managing Director, Christine Lagarde, said in November after the fund had approved a $12 billion three-year extended facility loan to Egypt in support of its reform program.

Since November, Cairo applied a set of procedures as a part of a comprehensive reform program endorsed by the IMF; including free floating the pound and slashing energy subsidies. These reforms were preceded with approving a civil service law and introducing a long-awaited value added tax (VAT) with the aim of raising LE32 billion in annual revenues.

Reform pains and gains

Egypt has reaped some early fruits from the reforms adopted so far, with foreign investors making a strong return to both the stock and local debt market, significant improvement in remittances from Egyptians abroad, and the country’s balance of payment. During the second quarter of the 2016/17 fiscal year, net foreign direct investment increased to $4.3 billion, up from $3.1 billion a year before. Portfolio investments also achieved a net inflow of $212.9 million against a net outflow of $1.6 billion. Total remittances from Egyptians abroad also rose by 19.7% during the three months following the flotation to reach $5 billion at the end of January.

Yet most Egyptians have been suffering from soaring price pressures since the November flotation, another blow to their incomes after the VAT implementation.
Inflation accelerated in Egypt since November on the back of the pound’s 50% plunge against the dollar after the flotation, coupled with the newly introduced VAT and subsidy cuts. Annual urban consumer inflation recorded a 30-year high in February, jumping from 28.1% in January to 30.2%, the highest in 30 years, while the monthly rate of overall price gains eased from 4.1% in January to 2.6% in February, according to state statistics body Central Agency for Public Mobilization and Statistics (CAPMAS).

“Both monthly headline and core inflation rates recorded the slowest pace since the pound flotation at 2.6% month-on-month,” Ramy Oraby, economist at Pharos Holding, says. He explains that the rise in the annual inflation rate in February was affected by a low base in the corresponding period of last year, reiterating his forecast that “the impact of the base effect [will] diminish gradually, starting Q4 [April].”

The pound’s recent depreciation against the dollar is “no surprise,” said Oraby, adding that it will not add significant inflationary pressure as the dollar remains below the December’s record high of LE19.

He further noted that foreign investors’ purchase of $300 million of Egyptian-pound denominated treasuries on Thursday should curb strong hikes in the exchange rate.
Jason Tuvey, Middle East economist at Capital Economics, agrees with Oraby. “Egyptian inflation jumped again in February but it is probably now close to peaking and is likely to start falling in the second half of the year.”


Bread protests sound the alarm

Reeling after record price hikes in the aftermath of bold economic reforms, Egyptians took to the streets and demonstrated outside bakeries in many cities early March, protesting the Ministry of Supply’s decision to scale back the amount of bread that can be sold to those not holding a smart card for subsided bread. To mitigate public anger and avoid further protests, the government revoked the decision.
The move has aroused concerns about the government’s intention to remove food subsidies in the 90 million-nation where around 28% of the population are living near or below poverty line.

Jerry Rice, IMF spokesperson and head of the communication department, does not echo the same concerns, however. “There is no plan to reduce food subsidies in the authorities’ programs supported by IMF’s EFF arrangement,” IMF spokesperson Jerry Rice tells bt.

He reiterated that social protection is an important element in the reform program supported by the fund. “We strongly support the decision of the government in November to increase food subsidies with budgetary savings that come from other measures. And I think what we’re seeing—to my understanding—is the transitioning to a better targeted system of subsidies.

According to the IMF agreement, the food subsidy bill went up from LE 41.5 billion last fiscal year to LE 48.5 billion in 2016/17 and is slated to go up to LE 51 billion, LE 53.2 billion, LE 53.4 billion and LE 54.4 EGP over the next four fiscal years respectively.

Reform challenges

The biggest challenge to the government appears to be alleviating the hardships Egyptians are suffering as a result of the bold reforms—reform program sustainability cannot be guaranteed otherwise.

Fuel subsidy is set to be scaled back from LE 62.2 billion in the current fiscal year to LE 36.5 billion and LE 19 billion in 2017/18 and 2018/19 respectively. This means that further fuel price hikes are inevitable to bridle the budget deficit.

Despite the social and political risks of implementing further tough reforms, professor XXfirst nameXXNafei says he sees no difficulty in achieving the reform actions on time. He notes that the Egyptian authorities can take advantage of the IMF admission’s in January that the pound plunged more than they had initially predicted to slow down the pace of reform to avoid public discontent.

“The authorities can persuade the fund to carry on the program over a longer period and a managed-flotation of the local currency should be considered to avert a third revolution. More than half of Egyptians are poor. The reform has both gains and pains and a balance must be created,” Nafei warns.


New budget . . . new challenge

Given the current social, political and economic circumstances, drafting Egypt’s budget for the coming fiscal year is quite a challenge. The government is stuck between the hammer of making progress on the austerity measures included in the reform program so as to receive the second tranche of the IMF loan and the anvil of arousing further social anger, which threatens Sisi’s chances in the upcoming presidential election in mid-2018.

Reducing the budget deficit is expected to be the major difficulty in preparing the new budget which already faces other challenges, such as pricing the dollar in light of the high fluctuation in the FX market and the hardship of increasing revenues by imposing more taxes,” says Nafei.

The Egyptian governments used to overestimate the projected GDP to reduce the expected deficit in percentage, Nafei explains. “This is no longer working. They have to think out of the box.”

At the end of last month Deputy Finance Minister Amr El Monayer announced a plan to increase tax revenues by 1% of GDP annually, an idea Nafei considers “unrealistic and unacceptable.” Increasing taxes will ultimately apply further pressure on economic growth in light of the high inflationary pressures, he explains, adding that it has already impacted consumption, a key driver of economic growth.

Revenues are projected to rise by around LE 59.5 billion to a total of LE 769.7 billion in the new budget, compared to LE 710 billion in 2016/17. Tax revenues, which make up roughly 68% of total revenues, are targeted to edge up to LE 584.4 billion from LE 473.2 billion, marking an increase of LE 111 billion.

“Such a hike in tax revenues might only be doable by widening the base of taxpayers, improving tax collection mechanisms, reconciliation in outstanding tax disputes and annexing the informal economy,” Nafei adds.


Why is Egypt’s budget deficit high?

The new figures and projections indicate that debt service payment, subsidies and wages are eating up the lion’s share of Egypt’s budget, forming 80.3% of total spending.
Expenditure is set to increase to LE 1.106 trillion in the new budget, versus LE 1.043 trillion projected during the current fiscal year. Wages are to comprise about 23% of total spending and projected at LE 255.3 billion, up from LE 228.7 billion in 2016/17).
The deficit is projected to hit LE336.8 billion, around 10% of GDP, down from 12.1% projected in the 2016/17 budget.

According to IMF documents, debt interest payments will surge from LE 315.8 billion to LE 384.5 billion in the new budget, an increase of LE 68.7 billion. This will eat up more than 34.7% of the budget. Subsidies will also acquire about 22.6%, while investments will drop from LE 150 billion to LE 94.4 billion to make up only 8.5% of the budget.

“This distribution must be reconsidered to increase allocations for investments and improve productivity and infrastructure, key drivers for economic growth,” says Nafei. Instead of increasing taxes or slashing more subsidies, the authorities should think about improving the efficiency and management of the electricity sector or the subway, for example rather than increasing the consumption tariff or the service cost, says Nafei, adding that “any planned wage hikes will not offset the inflationary pressures.”

The government should consider restructuring all sectors providing public services and analyze why they are not functioning properly, Nafei adds. Another way of generating revenues other than increasing taxes is selling land plots and collecting money from reconciliation in cases of land dredging or adverse possession, he suggests.

Positive outlook

Although Egypt’s economy is expected to slow down during this fiscal year due to the soaring inflation and tightened fiscal policies, a recovery is expected next year. “This year’s painful adjustment will help to set the stage for a recovery in 2018,” London-based Capital Economics said in a research paper titled “Middle East Economic Outlook.”

Leading independent macroeconomics research, analysis, forecasts and consultancy firm Capital Economics said the economy is projected to expand by only 1% in 2017, well below the official forecast of 3.8%, but growth should rebound to around 3.8% next year, as it expects “things should improve by 2018.”

The firm noted that “there are signs that Egypt is benefitting from a boost to competitiveness. This should support stronger export growth and dampen import demand, helping to narrow the wide current account shortfall.”

Egypt’s overall balance of payments’ (BOP) surplus surged to $5.1 billion in the second quarter of FY 2016/17 (October-December), from $1.9 billion the first quarter, according to data released by the Central Bank of Egypt upon announcing the flotation of the pound.

Since the big currency adjustment has likely happened, Capital Economics expects the pound to end 2017 at close to its current exchange rate (LE 18 to the dollar). This should put inflation on a downward path and the Central Bank should be encouraged to cut interest rates.

“Sisi and his government should tackle a hard equation of recreating balance between the necessity of mitigating public anger and meeting the IMF requirements; otherwise the regime cannot guarantee the reform program sustainability. It is incumbent on the government to take the hard decision and continue reforms as planned since Cairo cannot bear repercussions of an IMF punishment,” said Nafei, pointing to the IMF’s freezing of a second loan tranche worth USD 350 million scheduled last December for Tunisia because of lack of progress in reforms.



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