Three Immediate Economic Problems Sisi Must Tackle

Egypt's newly appointed Finance Minister Hany Kadry Dimian talks during a news conference in Cairo March 12, 2014. Dimian said on Wednesday that political instability would cause the economy to grow more slowly this year than earlier official forecasts showed, with the budget deficit also bigger than thought. (Photo: REUTERS/Mohamed Abd El Ghany)

The next Egyptian president, who by all accounts will be Abdel Fattah al-Sisi, is going to inherit an economy in distress. All of Egypt’s main macroeconomic indicators have gone south since the uprising that overthrew Hosni Mubarak in January 2011. Over the last three years economic growth has averaged only 2 percent per year, inflation has been in double digits, the unemployment rate shot up from 9 percent to over 13 percent, and the fiscal deficit has climbed from 8.3 percent of GDP to over 14 percent. Furthermore, as tourism collapsed and investors fled, the country’s international reserves fell from over $35 billion at the end of 2010 to $15 billion in 2013.

More importantly, the uprising exposed starkly the major fault lines in the economy that had been papered over by the relatively better macroeconomic performance during the last five years of the Mubarak regime. These include high rates of youth unemployment, estimated to be twice the overall unemployment rate, rampant and widespread corruption, crony capitalism, widening income and wealth inequalities, a growing informal economy thought to be one-half the size of the formal economy, and rising poverty rates. These economic grievances were a crucial factor in the uprisings and will keep festering until they are addressed.

So the new Sisi government faces the daunting task of turning the macroeconomic indicators around and undertaking policies aimed at correcting the deep-seated structural problems Egypt faces. It will require in the first instance a vision of the type of economic model Egypt should adopt. Should Egypt be a market-oriented and private-sector led economy or a state-dominated and controlled economy? The government will have to develop and implement a strategy to achieve this vision.

Sisi has yet to articulate his vision of the long-run future of the Egyptian economy or spell out the plans to move toward that objective. Some clues can, however, be gleaned from his interviews and speeches during the election campaign. He identified what he saw were the major economic challenges for Egypt—massive youth unemployment, dependency on foreign assistance, high rates of poverty, and large income inequalities—and offered a mixture of populist and traditional free-market policies, albeit without too many details, that could potentially address these challenges.

A comprehensive long-term plan based on the chosen economic model will presumably emerge once the new cabinet and the economic team is in place. This should not be long since by now the economic reforms that Egypt needs and how they should be implemented are well known. More relevant, the effects of these reforms will take time, and even Sisi recognized that “maybe a generation or two will not reap the benefits (of reform), but that may be necessary so others can live.

But there are three main economic problems on which Sisi’s government should move immediately: energy, public finances, and external financing.

Increasing energy supply

Egypt is in the midst of a serious energy crisis that has resulted in country-wide electricity shortages and frequent cuts in power. It is expected that these shortages will grow in the summer months. While the focus has mostly been on the hardships this creates for households, electricity shortages have also had a severe adverse impact on industry, which is currently operating at an average of 60-70 percent capacity. This naturally has resulted in a substantial reduction in industrial production and employment.

The proximate cause of the energy crisis in Egypt is lack of inputs. Installed electricity capacity is 24,700 megawatts while electricity consumption is only 13,000 megawatts. Egypt generates electricity mostly by using gas and oil, and the country’s inability to pay for inputs has led to a cutoff in supplies and a consequent fall in electricity generation. The solution, therefore, is not to add power plants but rather to ensure that oil and gas inputs are available to the existing plants. The key policies in this regard would be:

  • Eliminate payment arrears to international oil companies, currently amounting to $5.7 billion.
  • Raise electricity tariff rates for households and industry to a level that covers the costs of production and eliminates the government subsidies for electricity.
  • Obtain oil and gas from the Gulf Arab countries as grants or on a deferred-payment basis.

Stabilizing public finances

Over the past three years, government revenues have fallen by 2 percent of GDP, while government expenditures have risen by nearly 4 percent of GDP. With the rise in the fiscal deficit to 14 percent of GDP, government debt shot up to 90 percent of GDP from 73 percent in 2010. This is clearly unsustainable and the government will have to move aggressively to reverse these unfortunate trends in the public finances, a fact acknowledged by the Sisi campaign which calls for reducing the fiscal deficit to 8.5 percent over the next three years.

The important question will be how to improve the fiscal position without creating downward pressure on growth. The simple answer is that the country will need to create fiscal space to allow for expansionary spending policies that are essential in generating growth and jobs in the short-run. How can this be done?

  • Reform the expensive subsidies system that eats up 10 percent of GDP per year and a quarter of the government’s budget.
  • Obtain sufficient external financing to support a fiscal stimulus, which is necessary at a time when private spending and investment are falling.
  • Increase taxes on high-income earners and on luxury products.

Attracting external financing

With little near-term prospects of a turnaround in tourism and private capital inflows, Egypt will need substantial foreign support to fill a financing gap of some $16-20 billion in the coming fiscal year.

Furthermore, additional external financing will be needed for the country to obtain oil and gas imports to ease the energy crisis, as well as to support a fiscal stimulus. In 2013, soon after the fall of the Morsi government, Kuwait, Saudi Arabia, and the United Arab Emirates, announced a package of $12 billion to ease the pressure on Egypt’s external position and to provide funding for the government’s plans to invest in infrastructure, support industry, and increase wages. As such, Egypt was able to avert a full-blown foreign exchange crisis and possibly a complete collapse of the economy. It also enabled the previous government of Hazem El-Beblawi in 2013 to launch two fiscal stimulus packages worth $8.6 billion. The Sisi government will have to generate considerable external financing for the next 2-3 years and some of the ways to do that would be by:

  • Seeking further assistance from Gulf Arab countries of at least the same amount as was provided in 2013. This financing would be directed into both budgetary support and projects that Sisi has highlighted as essential to Egypt’s future—infrastructure, housing, and employment.
  • Negotiating a program with the International Monetary Fund (IMF). This could bring in $5-6 billion directly from the IMF on very favorable terms, as well as additional financing from the European Union and other international financial institutions whose support is conditional on an IMF program being in place.
  • Floating bonds in the international capital markets, which presently are flushed with liquidity, could easily generate $2-3 billion on relatively favorable terms and long maturities.

Major economic reforms are necessary if Egypt is to generate sustained high growth that will create sufficient jobs to absorb the new entrants into the labor market. These reforms will take time to yield their benefits. In the meantime, it is essential for the government to demonstrate that the economy is turning a corner. If the government can make sufficient progress in the energy, public finances, and external financing areas, it will likely be given time by the Egyptian public to put long-term economic reforms in place. Short-run economic success can breed long-term success; failure could spell major political troubles for Egypt down the road.

Mohsin Khan is a resident 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.