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Sunday, 18 August 2019

Egypt: Economic reform on track

As the government moves ahead with its programme of economic reforms, smoothing out their effects on the most vulnerable remains a priority, write Niveen Wahish and Sherine Abdel-Razek

Niveen Wahish and Sherine Abdel-Razek, Saturday 13 Jul 2019
Egypt
File photo: An Egyptian fruits seller is seen at a market in Cairo. Photo: REUTERS
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People in Egypt woke up on Friday to find petrol prices had increased that morning. The move had not come as a surprise, as they had been expecting it throughout June and knew it was going to happen as the 2019-2020 budget went into effect.

Fuel-price increases range from 17 per cent on the highest-grade unleaded gasoline 95 fuel used by high-performance and luxury cars to 30 per cent on the liquid gas canisters used by households in cooking. Both diesel, the fuel widely used by trucks and buses, and gasoline 80, used in heavy transport vehicles and agricultural tractors, increased by 22.7 per cent.

This is the fifth increase in fuel products since 2014 and the fourth since November 2016 when Egypt signed an agreement with the International Monetary Fund (IMF) that aimed at cutting the budget deficit through slashing energy subsidies, introducing a new value-added tax (VAT), and rationalising government administrative expenditures.

The energy subsidies had burdened public finances for years, representing more than 20 per cent of overall expenditures. Economists have long argued that money that went into fuel subsidies was not targeting those that really needed it, with a World Bank study showing that the highest income quintile receive around 60 per cent of all energy subsidies.

Moreover, the energy subsidies promoted capital-intensive rather than labour-intensive industries. Economists have long argued that subsidy money is better spent on improving education, health and the social safety network.

Previous governments were reluctant to reform the subsidy system for fear of stirring up social unrest. However, Egypt in its agreement with the IMF committed itself to lifting the subsidies gradually so that fuel is now to be sold to customers at its cost price at the beginning of the current fiscal year that began on 1 July. Moreover, electricity subsidies were cut by 15 per cent starting in July.

According to a statement by the Ministry of Petroleum, this price brings the cost coverage ratio to 100 per cent within the fuel segment. Diesel and liquid gas canisters are still 40 per cent subsidised, according to estimates by investment bank Beltone Financial Holding. 

The savings from the hike are estimated at LE37 billion, which puts the oil subsidies for the current fiscal year at LE53 billion based on the assumption that oil prices will be at $68 per barrel. Government estimates suggest that every $1 increase in oil prices above this level could add LE4-6 billion to its expenditure bill.

The next step is to adopt a price-indexation mechanism on fuel, which is an automatic pricing mechanism whereby prices will be set based on a calculation that takes into account international oil prices and the exchange rate. The system is already in the works for the higher end Octane 95 fuel and allows for price fluctuations of up to 10 per cent to be decided by a committee of officials from the finance and petroleum ministries every three months.

This does not mean that fuel might see another increase soon, however. “We do not expect movements in prices upon the indexation implementation given the current low petroleum prices trending below $70 per barrel and supported by a stronger pound,” Beltone said.

Besides car owners, users of public transportation were the ones to immediately feel the effects of the price hikes. Commuters were not happy to hear drivers breaking the news of yet another increase in the cost of each ride.

While transportation was directly affected by the price hikes, cutting subsidies will also indirectly affect inflation upwards.

Investment banks expect the resulting increase in the inflation rate to be mild and much less than the hikes caused by previous increases in fuel prices, however. “We expect a softer hike in commodities prices than that experienced in the two previous energy price increases, as it was partially priced in since the kick-off of the IMF-backed reform programme in November 2016 and given the weak purchasing power recovery,” Beltone noted, putting the increase at between seven to 10 per cent at most.

This, according to Beltone, would translate into 2.6 per cent on average in monthly inflation during the third quarter of 2019. “Annual inflation is expected to average 13.3 per cent in the third quarter, almost flat from 13 per cent in the previous quarter,” it added.

According to the government, the money saved by both the fuel and electricity subsidies lift will be channelled into spending on social measures. Beltone estimated these savings at LE43 billion and noted that petroleum bill savings alone would fund 45 per cent of the wage compensations package revealed by President Abdel-Fattah Al-Sisi recently, at an overall cost of LE60 billion and aimed at easing inflationary pressures resulting from fuel liberalisation.

The package includes raising the minimum wage to LE2,000 per month, increasing pensions for public employees to LE900 per month, and providing state employees with a LE150 one-off increase.

It will also see the inclusion of 100,000 families in the conditional cash-transfer programmes Takaful and Karama (Solidarity and Dignity). The first supports households with children, while the second targets the elderly and persons with disabilities who are unable to work.

Moreover, dozens of traders and producers are participating in the government-sponsored Kolena Wahed (We are All One) initiative, whereby discounted commodities are sold in fairs and mobile outlets provided by the government.

Egypt’s perseverance with the fiscal reforms has so far paid off in terms of macroeconomic stabilisation. Preliminary financial indices for the 2018-19 budget have shown that GDP growth reached 5.6 per cent, Presidency Spokesman Bassam Radi announced in a statement earlier this month. GDP growth ranged at around two per cent in 2016.

The budget deficit is expected to drop to a targeted 8.4 per cent of GDP, he said. Meanwhile, gross general government debt is expected to decline to about 85 per cent of GDP in 2018-19 from 103 per cent in 2016-17, according to the IMF.

While macroeconomic stabilisation is a short-term priority to restore confidence, enhance competitiveness, and ensure the sustainability of public finances, the efforts should be combined with a longer-term perspective on structural reforms, said the “Egypt’s Stocktaking” report prepared by the Organisation for Economic Cooperation and Development (OECD).

“The success in structural reforms, in particular aimed at boosting job creation, will determine whether Egypt goes beyond macroeconomic stabilisation to create sustainable growth, which is essential in the long run for social and economic stability,” the report said.

Nicolas Pinaud, head of the Sherpa Office and Global Governance Unit at the OECD, told Al-Ahram Weekly that it was important for Egypt to work on the quality of growth and how it trickles down to the population and not just the pace.

“There is a need to look at generating opportunities for the entire population, including the most vulnerable segments through, for example, education and training,” he said during an event organised last week by the Egyptian Centre for Economic Studies (ECES), a think tank.

When looking at Egypt’s peers in the region such as Morocco and Tunisia or to OECD middle-income countries like Mexico, Turkey and Greece, “Egypt is not doing well enough compared to those countries when it comes to inclusive growth,” Pinaud said.

He noted that despite existing social spending, poverty rates remained high, which meant they may need to be better targeted. As the report showed, “despite significant efforts to roll out Takaful and Karama, these programmes still need to be substantially scaled up to create an effective safety net covering Egypt’s vulnerable population, in particular given the impact of the ongoing adjustment on the poor,” he said.

 *A version of this article appears in print in the 11 July, 2019 edition of Al-Ahram Weekly under the headline: Economic reform on track

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