The Turnaround of the Egyptian Economy in 2014

Since January 2011, the Egyptian economy has been in a steady downward spiral. During the past three years economic growth averaged an anemic 2 percent per year, inflation was in double-digits, and the unemployment rate went from 9 percent in 2010 to over 13 percent in 2013. Finally, foreign exchange reserves of the Central Bank of Egypt (CBE) fell from over $35 billion to $17 billion in the course of the three years. It is only fair to conclude that economic performance in the last three years compares unfavorably on most macroeconomic indicators with the Hosni Mubarak years.

The main reason for the economic disarray has been the political uncertainties and constraints that prevented the governments of the Supreme Council of the Armed Forces (SCAF) and former president Mohamed Morsi from focusing on the economy. Neither government was willing or able to develop an economic plan to arrest the decline of the economy. Hazem El-Beblawy’s transitional government, which took power in August 2013 committed itself to boosting Egypt’s economic fortunes and formulated an economic plan containing four main elements:

  • Tackling the energy and input shortages that had seriously constrained industrial production.
  • Introducing a fiscal stimulus to increase consumption and employment.
  • Increasing the minimum wage to assist low income earners and thereby raise consumption and reduce income inequality.
  • Improving the external imbalances and building up foreign exchange reserves, thereby reducing the pressure on the exchange rate.

Based on this plan, despite the political turmoil that is likely to persist throughout this year, there are grounds to be optimistic about the outcome for the economy in 2014. Three factors are key to this expected turnaround.

First, Gulf Arab countries have opened their purses to assist the new government. The almost immediate announcement of $12 billion in assistance from Kuwait, Saudi Arabia, and the United Arab Emirates (UAE) after the fall of the Morsi government in July 2013, greatly eased the pressure on Egypt’s external position.  It also provided the government with budgetary resources to implement its economic plan. More such financing is in the pipeline as the Gulf Arab countries have pledged a further $6 billion in budgetary support for 2014 as well as $11 billion in infrastructure investments and projects over the next few years. All told, actual and expected Gulf financing amounts to over 10 percent of Egyptian GDP.

Second, Finance Minister Ahmed Galal made the right economic decision to undertake a Keynesian-type fiscal stimulus to increase production and consumption. When the transitional government took over, private spending and particularly investment were falling, so the government had to pick up the slack and expand public spending. Two stimulus packages worth $8.5 billion (about 3.5 percent of GDP) are in the works. The first one, implemented in October 2013, allocated EGP 30 billion for investments in infrastructure (roads and bridges, railroad crossings, the third metro line for Cairo, and social housing), support for factories and for restructuring state-owned enterprises, and increases in wages.  It is noteworthy that the International Monetary Fund (IMF) endorsed this fiscal expansion.

The second fiscal stimulus package of EGP 30 billion, yet to be implemented, envisions another EGP 20 billion for investments and EGP 10 billion to cover the increases in minimum wages for public sector employees. This increase in wages is in addition to the EGP 8 billion the government has allocated for salaries of public teachers and employees of Al-Azhar University.

Third, despite some false starts in both 2011 and 2012, it is likely that Egypt will enter into negotiations with the IMF for a program in 2014. So far the transitional government has taken the line that Egypt has sufficient financing available and does not need an IMF loan at this stage. That may well be, but the main reason is that the current government is just not ready to undertake the reforms that a typical IMF program would require. Major economic reforms are necessary if Egypt is to generate high sustained growth that would create sufficient jobs. These include reforming the expensive subsidies system that eats up 10 percent of GDP and a quarter of the government budget, the overly rigid labor market, the complex set of business and investment regulations, large-scale public sector employment, and the inefficient state-owned enterprises. These reforms are politically costly and the transitional government would rather leave them for the next elected government to undertake.

There are many advantages in having an IMF program and hopefully the new government will recognize the benefits. An IMF program would bring in financing, possibly as much as $5 billion at very favorable terms, and would open up the flow of additional financing from the European Union and other international financial institutions. It is also interesting to note that press reports claim that Egypt’s main benefactorsSaudi Arabia and the UAE—have advised it to negotiate an arrangement with the IMF. Beyond the financing, an IMF program would send a strong signal to investors and financial markets that Egypt is putting its economic house in order and is ready to implement the reforms that would place Egypt on a high-growth trajectory, creating sufficient jobs for the expanding labor force.

These three factors indicate that Egypt’s economic fortunes will improve in 2014. Growth in 2014 will thus be somewhat higher than the consensus 2-3 percent rate projected by the IMF, World Bank, the Institute of International Finance, the private credit rating agency Fitch, and Bloomberg. As the fiscal stimulus works its way through the economy, growth in 2014 could turn out to be close to 4 percent. This will represent a significant turnaround from the past three years, although it will still be below the growth rate in the last years of the Mubarak regime.

While unemployment will still remain high, a substantial number of jobs will be created by the infrastructure investments and increasing capacity utilization in industries. To make a significant dent in unemployment, Egypt needs to grow in excess of 6-7 percent per year on a sustained basis. Reaching 4 percent growth is only a start towards this goal. Inflation will also stabilize, although it will be in double-digits during the year. Finally, with the inflows of financing from the Gulf Arab countries, as well as potentially from the IMF, the EU, and other multilateral and bilateral donors, Egypt’s external position will show a significant improvement and ease any pressure on the Egyptian pound.

Already in 2014 there are positive signs that the economic picture is improving. For example, the stock market has surged to a 35-month high, and is expected to rise by 40 percent in 2014, indicating the growing confidence of investors in the economy. Foreign exchange reserves have been stable at around $18 billion, allowing the CBE to maintain the level of interest rates, as well as relax controls on currency transfers abroad. International banks expect the currency to be stable at about EGP 7 to the US dollar and are advising their clients to go long in the Egyptian pound. Fitch has raised Egypt’s credit rating from negative to stable, citing the financial aid the country is receiving from the Gulf Arab countries. Lastly, surveys of Egyptian businessmen show positive expectations for the economy in 2014.

Absent any serious political shocks, 2014 should be a better year than the previous three. The main achievement in 2014 will be stopping the economic decline and reversing the direction of the main macroeconomic indicators. The somewhat improved performance, however, does not mean that the Egyptian economy is out of the woods. The government’s initial task was to get the economy going and it took the lead in this regard. To date, growth is mostly government-driven. For growth to be sustained, however, the private sector has to take over the lead and major structural reforms will be needed to achieve this change. Nevertheless, if all goes well in 2014, the next government will inherit an economy in far better shape than the Morsi and the el-Beblawi governments did from their predecessors, and can build on the 2014 base. 

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.

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Image: Photo: Nasser Nouri