Egypt: Charting a Way Back to Growth

6 months ago Alger Mag Editor 0

The Tahrir Square protests are the most striking image of modern Egypt, the Arab world’s most populous nation. Although now characterized by its unstable political regimes, Egypt was not always so dismally perceived. Egypt launched bold reforms in 2004 that greatly benefitted the nation fiscally and by the end of 2007, 2.4 million new jobs had been created, GDP growth rate had reached an impressive 7.2%, and the nation’s fiscal deficit had dropped to a historic low (World Bank Data). The government rolled back expensive public subsidies and started a three year program to end industrial energy subsidies. Egypt was poised to become the model for economic growth in the Arab world.

Yet due to the heavy integration of the financial sector in Egypt’s real economy, the Great Recession of 2008 hurt its economy as a whole. GDP growth fell to 5.1 percent by 2010, Foreign Direct Investment in 2010 fell to almost half of its 2007 level, and exports as a share of GDP fell by a third of their initial amount between 2008 and 2010. Egypt’s major channels of revenue – Suez Canal flows, tourism, and exports – all took major hits.

The negative effects of the Great Recession had just started to take hold when the Arab Spring protests began in Tunisia, quickly spreading across the region and, in January 2011, flooding Tahrir Square in Cairo. Almost all economic indicators responded negatively as the nation was gripped in turmoil and saw one regime change after another. Meanwhile, an overvalued exchange rate reduced domestic competitiveness, depleted foreign reserves, and made traditional sources of external revenue less reliable. Tourism, historically a high source of revenue, has declined more than 62 percent since 2010 alone. Gross foreign reserves have dropped close to 57 percent since the revolts to unseat Mubarak in 2011. Egypt has been pushed off of the path of growth by an unfortunate position of economic and geopolitical tumult.

Abdel Fattah el-Sisi – who came into power in June of 2014 – promised economic reform through decreasing natural resource subsidies, cutting red tape, and increasing taxes. His failure to follow through on these promises and his focus on profligate projects rather than on basic infrastructure is indicative of the administration’s larger  reform priorities. Excessive focus on projects and policies that do not target fundamental economic problems like low employment participation, lack of access to basic services, and poor infrastructure may be politically helpful moves, but do not provide any long term benefits.  Damages to the public piping and irrigation systems have resulted in the wastage of 35 percent of all domestic water supply. Internal departments, such as the Ministry of Irrigation and Water, are so underfunded that they have disavowed water access as a priority. The foreign aid that Sisi’s administration squandered on the revitalization of the Suez Canal could have been better spent on improving infrastructure and filling in the nation’s budgetary gaps. The Canal revenue projections made by the government are wishful thinking, and these renovations are no more than a symbolic gesture.

However, even with these damaging policies, steps towards fiscal consolidation have helped Egypt avoid crises. The growth rate has increased to 4.9 percent in April 2016 from 1.82 percent in mid-2010, and budget deficit declined to 11.5 percent of GDP in 2015 from 13 percent in 2013.  The IMF’s approval of a $12 billion loan to Egypt in November 2016 came as welcome news after nearly a decade of macroeconomic and political instability. The loan – in combination with the November decision to liberalize exchange rates – will expand Egypt’s foreign reserves, make exports more competitive, and increase foreign direct investment.

The policies needed to move toward better fiscal consolidation that have already been instituted – the floating of the Egyptian Pound, increasing interest rates, VAT, and pragmatic subsidies have been set as preconditions for further aid from the IMF. And although economic growth indicators like GDP growth rate and deficit as a percent of GDP have seen positive turns over the last three years, Egypt’s future relies on the policy initiatives of the administration as the IMF’s austerity measures take hold.

The state’s decision to float its currency in order to attract foreign investment is a step in the right direction. The ensuing sharp devaluation of the Egyptian pound will help exports and increase foreign investments. Critics fear the move will lead to higher inflation, but the Central Bank of Egypt’s decision to raise interest rates by 3 percentage points aims to curtail these expectations.

The implementation of a Value Added Tax (VAT) will further increase government revenues, but as the August 2016 announcement declared, vulnerable populations who need access to affordable resources will be exempt from some of the VAT. Energy subsidies that are meant to help poor families usually have the counterproductive effect of eating away at the national budget and benefitting the rich – who consume more energy – more than they do the poor. Additional resources should be directed toward cash transfers to the poor, in food subsidies, and in programs that target healthcare and social welfare schemes that are needed throughout the country. These fiscal changes will make available more resources to improve public infrastructure throughout Egypt and for small to medium sized businesses.

Egypt must next ensure the affordability of basic necessities through rational food subsidies, the budgetary impacts of which can be offset by widening the tax base and through fiscal consolidation. While some such policies may be in conflict with any traditional IMF suggestions, they would be more politically feasible than austerity measures. The preconditions to the IMF assistance program will require some traditional consolidatory reforms, but the nation needs to focus on safeguarding against the rising poverty rate and the reducing affordability of essential utilities and services.

The barrier to Egypt’s escape from this economic quagmire is the conflict between the IMF’s austerity preconditions for its loan and the subsidy based domestic policies that Egypt isn’t undertaking to help its citizens. While following IMF conditions would help ease the fiscal burden needed to keep the nation afloat, austerity measures could prevent unrest against the current administration, and help reign in inflation. Given Egypt’s tumultuous political record over the last few years, maintaining stability is the best policy to pull the country back on the growth track. Egypt must now attempt to find a balance between productive infrastructure investments and pragmatic subsidies. By ensuring foreign investments, reigning in inflation, and improving conditions for citizens and local business owners, Egypt may once again be the economic center of the Middle East.

 

By: Mihir Baxi

Image taken from Ahmad Hammoud on Flickr Creative Commons