Transitional governments can be very weak, since they have no popular mandate, or very strong, since they do not have to face the electorate when their term ends. To arrest the decline of the economy and put it on a trajectory of high growth and job creation, Prime Minister Hazem el-Beblawi’s government will have to be the latter. It will need to do in less than one year what the governments of the Supreme Council of the Armed Forces (SCAF) and Mohamed Morsi were unable to do over two and a half years. This is by no means an easy task.

As yet, the transitional government has not come up with an economic plan, although to be fair it is early days. Ideally, what the government should do is immediately reopen negotiations with the International Monetary Fund (IMF) for a program designed to bring about macroeconomic stability. The program should be specifically focused on fixing public finances and the implementation of reforms aimed at addressing the major structural weaknesses in the economy. Beblawi has been a strong proponent of an IMF program, which would simultaneously give the country access to substantial external financing, and provide a strong signal to foreign investors and the financial markets that Egypt was putting its economic house in order.

However, despite Beblawi’s positive views on an IMF program, from the recent statements of Planning Minister Ashraf al-Araby and Finance Minister Ahmed Galal, it appears that an IMF program is off the table, at least for the time being. The argument is that the country has sufficient external financing available now from other sources and it does not need the financing an IMF program would generate. One can argue that this is precisely the right time to negotiate a program with the IMF. Since Egypt has the luxury of ample available external financing, an IMF program would not have the same degree of austerity as the two previous programs negotiated with the SCAF and Morsi governments.

What will the transitional government do?

So in the absence of an IMF program, what will the transitional government do? The government could of course implement an economic program without the IMF. But by doing so it would lose the signaling benefit of having an economic program supported and monitored by the IMF. Egypt would have to convince the international community and financial markets that their own program would achieve the same outcomes as an IMF program.

From recent statements in the press, it appears that the initial priorities of the government will be to:

• Address the energy and input shortages that have reduced manufacturing production.
• Increase wages to reduce strikes and walkouts by employees.
• Increase the minimum wage to assist low-income earners.
• Implement a fiscal stimulus to increase consumption and sales.

How all this can be done without increasing the fiscal deficit is unclear. For example, by definition a fiscal stimulus implies an increase in government expenditures and/or a reduction in taxes, both of which will lead to a widening of the fiscal deficit. Therefore, a rise in the fiscal deficit should be expected, and financed by the resources from the external assistance that Egypt is receiving.

Very little has been said so far on reforming the labor market, reducing public sector employment, improving a distorted and relatively inefficient financial system, and reorganizing and privatizing state-owned enterprises. More immediately, while it is clear that Beblawi and his economic team recognizes that the generalized subsidy system is unsustainable, they have been remarkably coy about if and when it will be replaced by a targeted system that meets the needs of lower-income groups. Admittedly, reforming the subsidy system is difficult politically as most Egyptians benefit from it and view it as an entitlement. Even Hosni Mubarak’s government was unable to reform the subsidy system despite its almost total control of the political landscape.

While the one-year term of the transitional government precludes implementing all the deep structural reforms the economy needs, it could make a determined start. Minister Galal’s statement that this government will lay the groundwork for economic reforms is only kicking the can down the road. These reforms have been studied and analyzed in great detail and there is really no mystery about how they can be technically implemented. What has been missing in the past is political courage by the last two Egyptian governments to follow through on the implementation.

If the transitional government restricts itself to short-term populist measures to buy social peace and perhaps get a short-lived spurt in growth, it will leave the next elected government with an even more difficult task of putting the economy right. It will also be quite an irony that the transitional government would have done what the Morsi government wanted to do but could not because of a lack of sufficient external financing. The Morsi government needed IMF financing, along with financing from other international financial institutions and donors, but this carried strings in the forms of conditions on the budget and international reserves. This transitional government is fortunate that Gulf financing has no economic conditionality and the government has freedom on how it wishes to use the funds without worrying too much about the fiscal and external consequences of populist policies.

What lies ahead?

Obviously, it is hard to say if the transitional government will leave the economy in better shape that the SCAF government bequeathed to the Morsi government, or the Morsi government to the current government. If it can buy social peace and put a reform agenda in train, it will have done its job. If not, the new elected government will inherit an economy that will still need a major transformation. In order to do that, the new government will need broad political support, which the transitional government does not have to be overly concerned about as long as it has the support of the military. It will also need enough external financing, which the transitional government has, to ease the impact of the economic reforms on the population. In the absence of any one of these two conditions, the new elected government will face a public waiting for its demands to be met for three and a half years. This public is not likely to be too patient.

Egypt has enormous economic potential and if the right policies and reforms are undertaken it will recover from its present difficulties and take its place in the ranks of the prosperous and well-managed emerging market economies. The transitional government has an opportunity to put Egypt on this path. It should seize this opportunity and not just simply mark time and muddle through its one-year term. Otherwise, it would be another wasted year.

To read the first 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.