With a new president elected and a new government appointed after three-and-a-half years of transition, now is the time to tackle Egypt’s accumulated problems.
On the one hand, the political situation needs a deeper look to allow us to reach a political settlement that will make the regime not just superficially stable in the short term but also sustainable in the long term. Parallel to this, the economic situation has become critical and can’t be left without embarking on some hard choices. With the government not now concerned about reaching a political settlement, the economic situation is the biggest challenge on the government’s agenda.
Looking at the Egyptian economy in a broad way, one finds five key challenges:
Security and energy: Security is a basic need for people and an even more basic requirement for any business investment.
Needless to say, the last three-and-a-half years have been extremely turbulent on that level, with a record number of protests and sit-ins along with aggression in handling them. With such a deteriorating security situation, it has become customary to hear about horrible crimes on a daily basis that have been circulated all over the world thanks to social media, driving away local and international investors.
Alongside security comes energy and its availability. Businesses cannot operate if they do not get a consistent energy supply. With repeated cuts in electricity and an inconsistent supply of natural gas to factories, businesses across different sectors find it very hard to operate, and the problem is critical to factories that need ongoing supplies of energy to avoid costly forced shutdowns.
It is useful to know that energy prices in Egypt have been raised several times since the 25 January Revolution, affecting the competitiveness of the private sector. But still the main complaint is about the consistency of supply rather than prices, especially since energy prices in Egypt are still below international levels.
The budget deficit and public debt: With the main expenditures in the budget of subsidies, salaries and interest exponentially increasing since the 25 January Revolution while the main revenue contributor, taxes, have become more limited, Egypt has been facing a continuously increasing budget deficit.
This reached LE 240 billion in the last fiscal year (13.8 per cent of GDP) and is expected to settle at around LE 200 billion this fiscal year (around 10-11 per cent of GDP) thanks to generous Gulf aid. Next fiscal year it is expected to see a deficit of LE 288 billion (12 per cent of GDP).
Such unprecedented levels of deficit have put huge pressure on the public debt, from which most of this deficit has been financed locally, resulting in a total public debt of close to 100 per cent of GDP. This has increased the debt burden to around one quarter of the budget and thus decreased the fiscal space available to tackle critical social issues. In addition, the expansion in local financing of the deficit has restrained the ability of local banks to extend financing to the private sector, thus exacerbating economic stagnation.
Balance of payments and currency devaluation: With the decrease in foreign currency inflows, mainly foreign direct investment (FDI) and tourism, and the increase in foreign currency outflows, mainly for imports, the balance of payments has seen a large deficit that has increased since early 2011, forcing the Central Bank to intervene in the market by injecting foreign currency from its reserves to prevent the Egyptian pound from massive devaluation.
The Central Bank had around $36 billion of official reserves in January 2011, which had decreased to nearly $15 billion by June 2012 when the last president took office, with billions of dollars having been channeled, wasted in the view of many, to protect the pound.
Since then, the reserves level has been stable at around $15-18 billion thanks to the generous aid of Qatar, Turkey and Libya during the last president’s tenure and the generous aid of Saudi Arabia, the United Arab Emirates and Kuwait over the last year. Such aid has allowed the Central Bank to continue its strategy of defending the currency to avoid inflation, but the generous aid has still not been able to kill off the currency black market.
The private sector and crowding out: The private sector, the engine for growth and job creation in an open-market economy, has been suffering over recent years due to the lack of political stability, the ongoing protests, and the lack of clarity on economic direction.
This situation has slowed down the economy, which grew at an average of two per cent over the last three years, pushing unemployment up to 13.4 per cent, a critically high level. Yet, one of the emerging challenges facing the private sector has been increasing crowding out.
The expansion of the government in local borrowing has put pressure on private-sector financing. In addition, the army’s role in the economy has significantly expanded over the last few years, especially last year when multi-billion dollar contracts for construction and infrastructure were awarded directly by the government to army companies, putting the private sector at a major disadvantage and aggravating economic stagnation.
It is no surprise to find that the expansion policy pursued by the government last year did not in fact yield the expected growth and employment targets.
Austerity, stagflation and social impacts: To handle such a complicated situation, the government last year adopted an expansion strategy to steer the economy, create jobs and make people feel the economy was improving.
However, this strategy has not been sustainable, and it has been obvious that the government would change course very soon, something which will happen in next year’s budget that includes a major reshuffle in budget items to cut the waste of energy subsidies going to the untargeted rich groups. Energy subsides are to be cut from LE 134 to LE 104 billion in the next fiscal year.
Parallel to the cut in energy subsidies, the government intends to increase spending on the social side. But despite the overall nominal increase in spending in next year’s budget, it is still considered to be a contraction budget in real terms after deducting the expected inflation. Such austerity measures, especially with regard to energy subsidies, have been long needed but they come at a cost, quite high on the social level, at a time when the poverty rate already exceeds 26 per cent.
The overall austerity will definitely increase the stagnation in the economy and will not help the economy to grow at the forecast 3.2 per cent. In addition, the decrease in subsidies will increase energy prices, which, even if targeted at the rich, will be partly passed on to the poor and the middle class, resulting in rising inflation. This means the economy could be trapped in stagflation, or stagnation coupled with inflation.
These problems are the key challenges now facing the Egyptian economy. They have been diagnosed for a long time, and solutions have been readily available. Yet, these solutions are likely to aggravate other problems as the issues are intertwined. The required austerity to decrease the budget deficit and local borrowing, as well as devaluing the pound to decrease the balance of payments deficit, will have a major impact on deepening the stagflation that Egypt has been going through and accordingly will worsen the conditions of the poor and middle class. These do not have a sufficient social safety net to absorb this, and thus a gradual approach is needed by the government.
The bottom line is that economic problems in Egypt have accumulated over many years and are interrelated. Yet, they can be recovered from, and it is important that the government starts tackling them while taking a 360 degree view in considering the social impacts of economic reform.
This means that adopting a balanced approach is a must in order to fight the stagflation that is expected to be our companion on the journey.
26 June 2014
This Article was published in "Al-Ahram Weekly"
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