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Necessary economic change in Egypt

Al-Sisi has introduced many necessary economic reforms at the price of possible unpopularity

Sherine Abdel-Razek , Thursday 15 Feb 2018
Total gas station
File Photo: Total gas station attendance in Cairo , Egypt, on February 24, 2016 (Reuters)
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Building on his popularity as the country’s saviour from Muslim Brotherhood rule, President Abdel-Fattah Al-Sisi started his first term in office by taking measures that the regime of former president Hosni Mubarak shied away from out of fears of social unrest. During his four years in office, President Al-Sisi has asked people to be patient as he introduces necessary economic reforms.

The political and economic upheavals following two revolutions in three years had left the economy muddling through and facing many serious problems. These were manifested in a high budget deficit, a severe shortage of foreign currency, an absence of foreign direct investment (FDI), and an almost stagnant economy with growth rates of 1-2 per cent.

To deal with the budget deficit, standing at 13 per cent of GDP in 2013 compared to eight per cent in 2010, the government slashed energy subsidies in a politically sensitive move that had been shelved for years, doing so not once but three times during four years.

Eating up almost 20 per cent of state expenditure, the move was inevitable. It included a plan to phase out subsidised electricity prices over five years, in addition to reducing fuel subsidies by sustainable amounts. It led to a 92 per cent increase in octane gas 92 prices, a 100 per cent jump in diesel, the most widely used fuel in Egypt, and a whopping 275 per cent increase in the price of gas canisters used by many households for cooking.

The country’s dwindling foreign currency reserves were one of the largest problems over Al-Sisi’s four years. The decline in tourism receipts and FDI due to the instability in the country and weak exports left government coffers with much-reduced inflows of hard currency.

Egypt’s foreign reserves, which stood at $36 billion in January 2011, declined to an average of $15.3 billion, $16.3 billion, $16.8 billion and $17.4 billion in 2012, 2013, 2014 and 2015, respectively.

In 2015, the foreign currency shortage had become exacerbated in a way that paralysed the economy, which depends heavily on imports. Many factories had stopped because they could not obtain dollars to buy raw materials and machinery, foreign investors had pulled out of the country as they could not obtain dollars to repatriate their profits, and foreign explorers had stopped their activities looking for oil, adding to the energy shortage and contributing to an energy crisis that left much of the country suffering blackouts.

The black market was thriving, with the difference between official and black market exchange rates reaching up to 100 per cent in the last quarter of 2016.

Millions of dollars of Gulf aid and international assistance failed to support the Egyptian pound through weekly auctions and thus made its floatation necessary.

According to the investment firm Prime Securities, the decision to float the pound in November 2016, accompanied by hiking interest rates by three per cent and issuing 20 per cent high-yield bonds, eliminated the black market and closed the gap between the official and parallel exchange rates.

They further helped in attracting inflows of portfolio investments, with $3 billion attracted within two weeks of the decision and reaching $19 billion by the end of September 2017.

The reserves strengthened and gradually increased to reach $38 billion in January 2018, enough to cover imports of more than seven months. The foreign exchange rate has been stable at an average of LE17.7 to the dollar. The floatation was part of an economic overhaul and a prerequisite for accessing a $12 billion IMF loan.

One of the main features of the past four years has been Egypt’s dependence on foreign aid and loans. In his first two years, Al-Sisi depended on generous Gulf aid to help the economy cushion its losses, with some estimates putting overall aid at around $35 billion.

But the money was often used to fill gaps or to support the pound, which had been in free fall. The decline in oil prices in 2014 hit the oil-rich Gulf economies hard, and the aid almost stopped by the end of 2015.

Since then there has been an increasing trend to borrow from international institutions and the international markets in the form of eurobonds. Egypt also accessed three tranches of the IMF loan, totalling =$6 billion, a $3 billion loan from the World Bank, and $1.5 billion from the African Development Bank, in addition to $7 billion worth of eurobonds.

This has led to an increase in foreign debt to reach $80 billion last month, compared to $56 billion in 2016.

Local debt is also increasing, pushing the overall debt, foreign and local, to LE3.7 trillion, according to the finance minister. This debt burdens the economy, with service payments alone representing 32 per cent of state expenditure.

The drop in the pound’s value, as well as introducing new taxes, fed inflation rates to unprecedented levels to reach 33 per cent last July. However, these started to cool down to 17.1 per cent in January and down from 21.9 per cent in December. Annual prices have been affected by the slowing rise in food and beverage prices, which make up the biggest single component of the basket of goods and services used to calculate inflation.

As for the taxes, while the government introduced a progressive income tax that reached 30 per cent on those with incomes exceeding LE1 mllion and a capital gains tax in 2014, two steps that have been welcomed as a means to fair taxation, a year later it unified the taxes on income at 22.5 per cent and froze the capital gains tax till May 2020. Moreover, it replaced the sales tax by a value added tax that is imposed on products and services and thus treat workers and employees in the same way as the wealthy.

Another feature of Al-Sisi’s term has been its focus on state-led mega-projects as a means to energise growth rates and create job opportunities. A myriad of projects have been introduced, starting with the New Suez Canal, the New Administrative Capital and the reclamation of 1.5 million feddans of land.

While investment in these projects has been the main driver of growth over past years, they have also raised reservations because most of these projects are executed by public-sector companies or army institutions with the limited presence of the private sector.

The government under Al-Sisi has also tried to attract FDI by amending the investment law and hosting the Egypt Economic Development Conference in Sharm El-Sheikh in 2015. The government slashed taxes to 22.5 per cent on the eve of the conference to allure investors.

However, a distorted forex policy, together with problems with the amended investment law, limited investment. Things were better starting in the second half of last year, when a series of laws were passed including an investment law, an industrial licensing law and a bankruptcy bill.

The increased investment that Egypt has seen this year is a positive sign, with several new investors promising entry to the Egyptian market. Joint US-Saudi Arabian investment worth $3.3 billion is scheduled to establish a Disneyland-style amusement park in Marsa Matrouh on Egypt’s North Coast. The UAE-based Al-Ghoreir Group also recently signed a $1 billion investment project that is expected to meet 80 per cent of sugar consumption in Egypt.

The restrictions on imports together with the cheap local currency tightened the trade deficit by 8.4 per cent in the year ending in June 2017, as export proceeds went up by around 16 per cent after four years of deterioration, registering $21.7 billion versus $18.7 billion the previous year.

Import payments slightly decreased by around 0.5 per cent to register $57.1 billion due to “the decline in non-oil imports by $2.2 billion that was offset in large part by the increase in oil imports by $1.9 billion”, noted Prime Securities.

Egypt’s balance of payment figures in general flourished significantly by the end of 2017, recording a surplus of around $13.7 billion compared to a deficit of $2.8 billion by the end of the 2016 financial year. Portfolio investments registered their highest jump since 2011 from an outflow of $1.29 billion in the 2016 financial year to an inflow of $15.99 billion in the 2017 financial year and $19 billion until the end of September 2017.

Tourism revenues have increased by 16.2 per cent and are still increasing when compared on quarterly basis. Tourism revenues registered $4.37 billion in the 2017 financial year compared to $3.8 billion a year earlier. 

* This story was first published in Al-Ahram Weekly

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