More than two and a half years after the 2011 popular uprising, Egypt’s double transition, political and economic, remains complex. As the political uncertainty remains fluid and continues to unfold, the economy suffers. The time to act is now as economic challenges are a moving target. The new government must immediately develop a home-grown coherent reform agenda with clear policy objectives and the main tools to achieve them.
The most immediate concerns should be bridging growing financing needs and activating the economy. To these ends, foreign borrowing from international institutions is an option to consider as relying on piecemeal financing from neighboring countries is not sustainable. Finally, political unrest should settle soon in order for economic reforms to reap their intended benefits.
Egypt has escaped recession so far, but financing constraints are getting tighter
Despite the turbulent political and social contexts and the unfavorable external environment, the Egyptian economy has so far managed not to fall into a recession but growth dropped from 5 percent in 2010 to around 2 percent in 2011 and 2012, with some early signs of a mild recovery in 2013. Yet, as job creation remains minimal, unemployed has soared to 13 percent, up from 9 percent before the uprising. Moreover, the external position has significantly deteriorated on the back of limited export growth (especially non-oil exports) and a sharp fall in tourism revenues. Despite a record-high increase in remittances of Egyptians living abroad, the current account deficit deteriorated to 3percent of GDP.
More worryingly, the significant drop in major foreign exchange earnings has put the official exchange rate under pressure, losing around 17 percent of its value between December 2010 and March 2013. In order to counter that, the Central Bank of Egypt (CBE) resorted to reserve depletion, eroding close to US$ 20 billion of reserves. After having fallen to critical levels of around US$ 14.9 billion and less than three months of imports, reserve levels were boosted to US$ 18.8 billion thanks to aid from the Gulf states..
Moreover, in an effort to respond to social demands and lessen the impact of high international prices for food and energy, the government increased spending on subsidies and civil servants wages (which both account more than half of total spending). The resulting large fiscal deficits (close to 11 percent of GDP) raised public debt (70 percent of GDP) which is primarily financed by domestic banks and thus constrain their capacity to lend to the private sector. Another alarming observation is the widening sovereign spreads which contribute to increasing the cost of government borrowing: the 91-day T-bill rate increased by 436 bps between December 2010 and April 2013.
A coherent and clear direction for economic policy
Successive governments after Hosni Mubarak’s fall, including the last one, have failed to articulate a coherent economic plan to tackle Egypt’s problems. Announcing a home-grown reform agenda could be useful in many ways. First, it can contribute to reducing uncertainty about future policy actions and may thus encourage economic agents, investors and consumers, to make decisions about spending, savings and investment. Second, transparency about policy objectives should increase public understanding of policy’s consequences but most importantly strengthen the role of public monitoring. In other words, it would create an accountability mechanism for the government towards its citizens. In this regard, a good communication strategy is required, one that explains to the laymen the justifications for reform, their intended benefits and expected costs. This could also increase the social acceptability of some painful reforms. Finally, by matching word with deed, the government will be able establish a good track record which will help it gain credibility and the trust of citizens.
What should the plan be?
There is little doubt on the immediate reforms to be adopted. The economy is in need of macroeconomic stabilization and policies to boost the economy. To stop reserve erosion, which have fallen to critical levels, the CBE could introduce further flexibility to the exchange rate regime and seriously seek borrowing money from abroad. Allowing more fluctuations in the exchange rate is not cost-free. It is likely to induce inflation, as imports will become more expensive.
As for fiscal policy, Egypt needs austerity measures to get its public finances under control. However, given the composition of public expenditure (with current spending items like wages, subsides and interest payments accounting for most of the spending), it may be difficult to introduce cuts in the short-term. However, the government could redesign the subsidy system towards the poor and avoid hiring more people in the public service. The government must also avoid increasing taxes as this may depress household consumption, which has been the main buffer to the drop in investment and external demand over the past few years.
To support growth and job creation, fiscal policy must not be contractionary. To boost employment, temporary fiscal and financial incentives could be given to the private sector to increase hiring particularly in the tourism sector. Additionally, training and credit subsidies could be offered to SMEs and labor-intensive sectors. Estimations by the IMF suggest that an investment in labor-intensive infrastructure of 1 percent of GDP could create about 87,000 new jobs in Egypt. In implementing these policies, the government needs to be mindful of fiscal sustainability concerns.
To borrow or not to borrow?
Clearly, Egypt needs to finance the above reforms. The financing gap was estimated (in March/April 2012) at around US$11 billion for eighteen months. It was recently able to secure US$12bn of financial support from Kuwait, Saudi Arabia and the UAE. One quarter of the money is in the form of grants, and the bulk of the remainder will be used to prop up foreign reserves. Is this the best course of action? Certainly, this money will temporarily mitigate reserve erosion. Yet, this emergency measure is not sustainable, especially if foreign exchange earnings do not rebound soon.
In this context, borrowing from international institutions is an option to resort to. The benefit of such borrowing is that it is usually associated with some adjustment to economic policies to “overcome the problems that led to seek funding in the first place.” External borrowing is not likely to compromise external debt sustainability, since external debt is relatively low around 16 percent of GDP. Given the numerous downgrades in sovereign ratings since January 2011, it is also hoped that an IMF loan will act as a positive signal to boost the confidence of investors and other potential lenders.
A critical challenge for Egypt is to make necessary reforms (like the devaluation) socially acceptable, given the growing feeling of national identity since the uprising and also skepticism towards reforms advocated by international institutions and implemented by the former regimes and finger-pointed to be the reason for rising inequality. To remedy that, the government needs to develop a home-grown reform agenda, launch a public debate about it and develop a good communication strategy to explain it.