Since the fall of Hosni Mubarak in January 2011, the Egyptian economy has been struggling. While much of the blame for the economic problems that the country is facing is directed at the Morsi government that took office in June 2012, the decline started over a year earlier. Indeed, in many respects economic performance under the Supreme Council of the Armed Forces (SCAF) regime that ruled the country from February 2011 through June 2012 was equally dismal. Essentially, the past two and a half years have been wasted and compare quite unfavorably on most indicators with economic developments during the last few years of the Mubarak regime.

To get an overall picture of the situation, it is worthwhile to look at some headline numbers. In the SCAF-Morsi years, growth fell to only 2 percent a year, inflation averaged over 10 percent, and the official unemployment rate rose from 9 percent to 13 percent. Government macroeconomic policies were relatively unchanged between the SCAF and Morsi governments. The fiscal deficit as a share of GDP remained in double digits and was financed primarily by government borrowing from the banking system.

One area where the SCAF regime bears considerable responsibility for ill-advised policies is maintaining the stability of the currency despite growing external imbalances. The result was a loss of over $20 billion in international reserves over a period of fifteen months.  Having inherited $35 billion in international reserves held at the Central Bank of Egypt (CBE), the SCAF government managed to squander nearly 60 percent of it, leaving the next government less than $15 billion in reserves. With the help of friendly Arab countries, the Morsi government was at least able to maintain this level of international reserves through the year it was in power.

Initial reactions to the change in government

The military-installed transitional government has been greeted with enthusiasm in the belief that it will stop the slide and turn the Egyptian economy around soon. The appointment ofprominent and well-respected economists, such as Prime Minister Hazem el-Beblawi, Minister of Finance Ahmed Galal, and Minister of Planning Ashraf al-Araby, as well as Deputy Prime Minister Ziad Bahaa-Eldin, a lawyer specializing in financial issues, has given hope to Egyptians of a new economic dawn. The media received these appointments very positively taking the view that these “liberal” economists have the requisite expertise and experience to reverse Egypt’s fortunes.

There is no question about the ability of the new economic team and their appointment is a welcome development. This group is on par with the economic team assembled by Ahmed Nazif, the last prime minister in the Mubarak regime, which included Finance Minister Youssef Boutros-Ghali, Foreign Trade Minister Rachid Mohamed Rachid, and Investment Minister Mahmoud Mohieldin. But even though the members of the new team have been characterized as liberal economists, presumably because they are pro-market and private-sector oriented, they believe strongly in inclusive growth and social justice, and therefore see an important role for government in driving the economy. Thus, it is expected that their policies will be somewhat different from the ones favored and implemented by Nazif’s economic team.

The appointment of the transitional government has already led to some positive economic developments, although more associated with politics rather than the result of any specific economic measures. The almost immediate receipt of $12 billion in external assistance from Kuwait, Saudi Arabia, and the United Arab Emirates, motivated largely by political considerations, has greatly eased the pressure on the country’s external position. The announcement by billionaire Naguib Sawiris of Orascom, that he and other investors will be “investing in Egypt like never before” is also reflective of the change in political regimes rather than any observed improvement in economic fundamentals. The stock market rose sharply, with the EGX 30 index rising by 6 percent in 1 day on July 4, although it has given up some of the gains in recent days as the security situation has deteriorated. Finally, the inflow of Gulf money has led to some strengthening of the Egyptian Pound.

Reforms or populism?

After the fall of Hosni Mubarak, and the discrediting of the economic policies his government had implemented, there was a question of what type of economic model Egypt would adopt.  Would the country continue with market-oriented reforms or would it adopt populist economic policies to cater to the immediate demands of the population that were a major factor in the January 2011 uprising? Unfortunately, neither the SCAF government nor the Morsi government was willing or able to articulate, let alone implement, the type of economic model relevant for Egypt.

For Egypt to become a dynamic and vibrant economy that can compete in a globalized world and create sufficient jobs for its young and growing labor force, it needs to follow through on the economic reforms initiated by the Ahmed Nazif government. These reforms are necessary for the long-run prosperity and development of Egypt. A cursory look at how other developing countries have adopted market-oriented reforms—in Asia or in Latin America—should be convincing evidence of their value. The adverse consequences of these reforms, and in the short-run there are many, can be dealt with through appropriate supporting economic measures.

More specifically, for Egypt to become a truly market-oriented economy the government needs to undertake a number of structural reforms, including:

Rationalizing the extensive subsidy system that annually eats up 10 percent of GDP and a quarter of the government budget.

  • Widening the tax base without inhibiting investment and job creation.
  • Reducing public sector employment which today accounts for a quarter of total employment in the country.
  • Streamlining business and investment regulations to encourage both domestic and foreign investments. 
  • Improving labor market flexibility by changing labor laws and regulations that constrain employments.
  • Advancing the privatization process to reduce the burden on the budget and bring efficiency into the operation of state-owned enterprises and banks.

The SCAF government avoided making any significant economic changes, arguing that this would have to wait for an elected government. No real reforms were initiated, although some populist measures were introduced, such as the creation of 400,000 new jobs in the public sector. There was a plan in mid-2011 to increase taxes and reduce subsidies, but this was quickly abandoned. It is worth mentioning that the current prime minister Beblawi was the minister of finance in the SCAF government for six months in 2011. Under his watch, the fiscal deficit continued to grow, the CBE lost $8 billion of its international reserves, and no meaningful economic reforms were introduced.

Unfortunately, the Freedom and Justice Party (FJP) had no experience in running the economy. Undertaking the appropriate economic policies and reforms thus proved to be anoverwhelming challenge. In fact, economic issues took a backseat for the first nine months of its tenure as the Morsi government was totally preoccupied with political issues. An economic plan, that was to form the basis of an International Monetary Fund (IMF) program, was finally developed by Prime Minister Hisham Qandil’s economic team towards the end of 2012. This plan blended populist measures, such as increases in social spending, with reforms of the subsidy system. In the end, faced with fierce political opposition from even its supporters, the plan was put on hold and then time ran out for the Morsi government. 

To read the second installment of this article, click here

Mohsin Khan is a senior fellow in the Rafik Hariri Center for the Middle East focusing on the economic dimensions of transition in the Middle East and North Africa.