Who Loses from Cutting Off US Military Aid to Egypt?

Whether Egyptian President Mohamed Morsi’s recent ouster was a coup or not is a much debated topic in Washington circles, as analysts, government officials and pundits struggle over the question of suspending military aid to Egypt. Most analysts and many US politicians conclude that a coup is a coup and US law says military aid has to be stopped, or at least suspended, until Egypt re-embarks on a democratic path.

The US government is stalling on this issue by not making a “determination” on whether the Morsi’s overthrow represents a coup. It has backtracked from Secretary of State John Kerry’s unfortunate and widely quoted recent statement in Pakistan that the Egyptian military was “restoring democracy.” It has since made some gestures of unhappiness at the actions of the Egyptian military, such as the cancelling of the Bright Star joint military exercises and the delivery of four F-16 fighter jets that had been ordered by Egypt. Nonetheless, the US administration has not yet come out one way or the other on the coup question and for now military aid continues.

There are several arguments made by the US government for continuing military aid and maintaining ties and communications with the Egyptian military. US aid to Egypt ensures regional stability, keeps intact the peace treaty with Israel, assists in the fight against terrorism, contains Iran, and expedites the transit of US warships through the Suez Canal. Cutting off aid would break US ties and leverage with the Egyptian military and jeopardize some or all of these shared objectives.

However, not too much has been said about the economic costs and benefits of cutting military aid to Egypt. Specifically, who loses if such aid disappears even temporarily? Is it the Egyptian military, the Egyptian economy, or the United States?

US Military Assistance to Egypt

It is useful to consider some facts on how the aid system operates. US foreign military financing (FMF) to Egypt amounts to $1.3 billion a year; this was a key part of the Camp David Accords of 1979. The FMF funds are to be used for weapons acquisition, upgrades to existing equipment, and follow-on technical support and maintenance. A generally unrecognized feature of this aid is that the funds do not go directly to Egypt, but are deposited in an interest-bearing account at the Federal Reserve Bank of New York. Although the $1.3 billion must be spent in full every year, Egypt’s military is allowed to negotiate major arms purchases spanning multiple year payments. Israel is the only other recipient of US military aid with the same flexibility.

Another very important aspect of the arrangement is that the Pentagon, not Egypt, signs the contracts with US companies to deliver the equipment and related services required by Egypt. As a result, the United States, and not Egypt, is liable legally for any unpaid funds if the contract is broken.

Impact on the Egyptian military

To start with, a cut off of military aid today would have no immediate impact on the Egyptian military since the funds for 2013 were already transferred in May of this year and the next round would only be dispersed in the spring of 2014. Eventually, of course there would be an impact as it is estimated by the Congressional Research Service that as much as 80 percent of Egypt’s weapons acquisition costs are covered by the annual $1.3 billion that the United States provides. If Egypt wished to continue to buy US weaponry and support, it would have to generate the necessary funds itself to do so.

This is unlikely to be a significant problem for the Egyptian military, which by all accounts is a wealthy institution. It has been estimated that the military directly owns or controls some 40 percent of Egypt’s GDP of $240 billion. It also apparently has substantial liquid assets, including foreign currency accounts. In the transitional period following Hosni Mubarak’s ouster, the then-ruling Supreme Council of the Armed Forces demonstrated an interesting example of the military’s access to foreign currency. With Egypt in desperate need of foreign exchange at the end of 2011, the military provided a $1 billion loan to the Egyptian government to tide it over.

Furthermore, it is interesting to note in this context that even the plant in Egypt that assembles M1A1 Abrams tanks also manufactures commercial construction vehicles and sells them in the domestic market under a virtual monopoly. Presumably, if the transfer of tank kits were stopped, production of the construction vehicles could be expanded and continued to be sold in Egypt and possibly also exported.

It is hard to imagine that, if the military wanted to have the $1.3 billion a year, it would any problem in obtaining the funds from the current military-installed government. After all, the transitional government is currently flush with external financing having recently received grants and loans of $12 billion from Kuwait, Saudi Arabia, and the United Arab Emirates.

Impact on the Egyptian economy

There is no direct impact of the US military aid on the Egyptian economy as the funds never actually enter Egypt and are kept in New York. Therefore, they do not figure in the budgetary or balance of payments accounts of the country. Presumably, they are reported in the military budget, which is kept secret even from the Egyptian government.

If the military wanted to replace the lost $1.3 billion from the government rather than its own resources, then obviously the funds would have to come from the government’s foreign reserves or from external financing. Given that Egypt this year needs around $20 billion in foreign financing, another $1.3 billion is not going to add a significant amount to its overall financing needs. Its financing gap will simply be $21.3 billion. Besides, the existence of the Gulf Arab states financing, and their promises of future financing, will be more than enough to cover the military’s demands.

Impact on the US

There are a host of US companies that benefit from US military aid to Egypt. The major one is Lockheed Martin, which signed a $2.5 billion contract in 2010 to deliver twenty F-16 fighter jets by December 2014. General Dynamics also has a large contract of $395 million to deliver 125 M1A1 Abrams tank kits to Egypt by January 2016. Another highly-visible company is Boeing, which is providing Apache helicopters—the same helicopters that have been flying over the pro-and-anti Morsi demonstrations. All in all, some forty US companies currently have contracts to provide equipment and technical support to the Egyptian military.

Since Egypt is allowed to place orders stretching over several years, and has been doing so, the outstanding orders far exceed the annual aid flow. It is estimated that only $4.7 billion of the $8.5 billion in weapons orders placed by Egypt since 2008 have been delivered to date. As such, US companies stand to take a $3.8 billion hit if military aid is cut off.

However, as the Pentagon signs the contracts with US companies, ultimately it is the US government that is liable for any unpaid bills resulting from the cancelation of the contracts. For example, in the case of Lockheed Martin, the Pentagon has yet to pay $1.7 billion of the $2.5 billion original contract, and General Dynamics has $220 million outstanding out of its $395 million contract. In the event of cancelation, the Pentagon would have to negotiate a termination penalty, buy the weapons for its own use, or sell them to another country. Otherwise, the US taxpayer would be on the hook for the value of the outstanding contracts.

Who then loses from the cut off in military aid?

The main economic costs of a cut off in military aid would fall on the United States, not on Egypt or the Egyptian military. These costs would include termination fees, including some reasonable profits, which would be incurred from the cancelation of contracts with US companies. The US administration is presumably making its decision on whether or not to cut off military aid to Egypt on the grounds of maintaining its ties, not necessarily leverage which seems to have been lost, with the Egyptian military in the interest of regional stability, security, and continued peace with Israel.

Additionally one could also argue that by continuing military aid the United States also saves itself from the economic costs that would be incurred if it were to take the high moral ground and suspend its military assistance to Egypt.

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.

Photo: Ahmed Al-Hilali