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Economic reform in Egypt: Challenges and prospects

The government’s ongoing economic reform programme is designed to put an end to years of economic mismanagement and stop-gap solutions

Alia Al-Mahdi , Thursday 1 Feb 2018
Abdel Fattah El Sisi
Egyptian president Abdel Fattah El Sisi delivered his ‘economic roadmap’ during the Egypt Economic Development Conference in March 2015 (Photo: Reuters)
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It has been seven years since the 25 January Revolution, a period in which all of Egypt’s economic indicators have plunged. It has also been a period of political and security upheaval and of sharp swings in government, with the Supreme Council of the Armed Forces (SCAF) giving way to Islamist president Mohamed Morsi and the Muslim Brotherhood and then the presidency of Abdel-Fattah Al-Sisi.

The country’s economic management fluctuated according to the regime in power. The SCAF had little economic experience, which was why the period from February 2011 to June 2012 was one of short-sighted politically motivated concessions and economic mismanagement. The government at the time haphazardly conceded to numerous class and labour demands regarding wages and salaries. While this may have helped to bring about a certain superficial stability, the measures were at odds with the levels of public revenues.

Starting in April 2011, the government also began to issue currency at an unprecedented rate, the purpose being to meet wage increase demands. At the same time, the government also expanded public-sector employment, also to appease labour demands.

In tandem with these practices, which continued under the Morsi regime (2012-2013), the government tried to keep the exchange rate of the Egyptian pound fixed at its pre-2011 level in spite of the fact that foreign transactions were steadily declining, both in terms of direct foreign investment and of tourism and export revenues.

The attempts to prop up the Egyptian pound eroded the country’s foreign currency reserves, which plunged from $45 billion in January 2011 to an all-time low of $12 billion in August 2013.

At the outset of President Al-Sisi’s rule in July 2014, it was only natural that the government would adopt a clear and cohesive economic reform programme.

However, due to the delay in implementing this, Egypt had to pursue two courses in order to remedy its most pressing problems, such as the poor economic growth rates and diminished foreign currency reserves, as well as to furnish the fuel and energy needed for domestic and industrial purposes.

The first course was to rely on Arab aid and investment. The second was to expand borrowing domestically and abroad. Both courses are dependent on attractive but unstable external sources.

This assessment of the government’s economic reform programme will look at three basic points: the state of the economy before the implementation of the reform programme in November 2016; the features of the programme and its most important consequences; and the future outlook for economic reform.

BEFORE NOVEMBER 2016

In order to judge the economic performance of any country, it is necessary to rely on a number of well-defined indicators, among them the rate of growth of GDP, the inflation rate, and the unemployment rate.

However, these three indicators alone are not enough to accurately describe the state of the economy in a country the size of Egypt and with its particular circumstances. Other basic fiscal and financial variables need to be taken into account, such as the budget deficit, the volume of domestic and foreign debt, and the balance of payments situation.

Egypt’s poor economic performance before November 2016 was manifested as follows:

Firstly, GDP growth rates were on average poor and never exceeded three per cent at best. In addition to low levels of new investment, this was due to the underuse of the industrial and service sectors, whether because of interruptions of fuel for major factories or to the drop-off in tourist visitor rates and revenues.

They were also the product of a poor investment climate, as a result of delays in promulgating the new investment law and its bylaws and other laws such as insurance and labour laws, and the lack of a clear and forward-looking vision of the economic role of the state and how it can encourage private enterprise beyond the small enterprises that were the focus of an initiative for which LE200 billion was earmarked by the Central Bank of Egypt (CBE).

Another aggravating factor was the wariness of foreign investors to risk direct investment in anything in the Egyptian market apart from the oil and gas sector.

This hesitancy was due to the government’s lack of clarity in its policies regarding the exchange rate and the role of the private sector, as well as the growing role of military investments in the civilian sector and its consequent increased economic rivalry with the private sector.

Secondly, unemployment over the past six years climbed to over 13.3 per cent in 2013/2014. It declined to 12.7 per cent in 2015 as the economy began to pick up again.

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(Photo: Reuters)

Thirdly, the budget deficit rose from around eight per cent of GDP in 2010 to 13.3 per cent in 2013, after which it declined to 10 per cent or more by 2016. The decline was due to the influx of Arab financial assistance and to the international loans the government was able to procure following the 30 June Revolution. Even so, the deficit remains relatively high.

Fourthly, the national debt rose from 74 per cent of GDP in 2010 to 92.3 per cent of GDP in 2016.

Fifthly, the volume of foreign debt, standing at $33 billion in 2010, soared to $80 billion by the end of 2017.

In short, the fragile economy demanded effective interventions within the framework of a clearly defined economic reform programme that would restore economic balance and revive the moderate growth rates that had been attained before 25 January 2011 and, hopefully, surpass them.

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THE REFORM PROGRAMME

The idea of implementing a wide-ranging economic reform programme first surfaced around the end of the rule of SCAF and the beginning of Morsi’s rule. There was talk of support from the IMF and the possibility of a loan of up to $3.5 billion, but vehement opposition shelved the idea.

It resurfaced at the beginning of Al-Sisi’s rule, but it was only fleshed out in the middle of 2016. A proposal was presented to the IMF board at the end of that year, and the board then agreed to offer Egypt a $12 billion loan over three years. This had various purposes, the most important of which were to restore overall economic equilibrium and to remedy the many problems plaguing the economy.

The following measures were adopted:

Firstly, the exchange rate was deregulated in order to revive confidence in the economy.

Secondly, a prudent and deflationary monetary policy was introduced in order to counter inflation and increase the country’s foreign currency reserves.

Thirdly, a new value-added tax (VAT) was introduced and energy subsidies were lifted in order to reduce the national budget deficit. At the same time, some financial resources were used to offset the impact of the programme on the poor and those on limited incomes.

Fourthly, structural reforms were introduced to ensure job creation and a more appropriate work environment. These included measures to facilitate the issuing of licences for start-ups and improvements to both the public and private financial management of public-sector companies, the electricity sector and the subsidies sector.

The reform measures began to be implemented prior to obtaining the IMF loan. In the 2014/2015 fiscal year, the government hiked energy prices and interest rates in order to absorb potential inflation. However, it was with the beginning of the implementation of the reform programme in November 2016 that the Egyptian pound was floated against the dollar and other currencies, fuel subsidies were reduced, and the VAT was introduced.

The combined effect was an unprecedented surge in inflation as the dollar soared from LE7.8 to LE20 at the outset of 2017, even if this gradually tapered off and settled at about LE17.7.

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(Photo: Reuters)

Large increases in the issuing of new currency aggravated the situation, sending inflation up to 34 per cent at the outset of 2017. The prices of food and consumer goods, as well as services, soared. All classes of society were affected, although the hardest hit were the poor and those on limited incomes.

In mid-2015, the poverty rate in Egypt was estimated at 27.8 per cent. With the rising inflation, although no household consumption and spending survey had been conducted, analysts estimated that the poverty rate had surpassed 33 per cent.

As the economic reform programme continued, the economic indicators began to show some improvement. GDP grew by 4.3 per cent in 2016/2017. Inflation fell to 26 per cent in November 2017. The unemployment rate declined to 12 per cent in November 2017. The government expects growth in GDP to rise further to 4.9 per cent during the first quarter of 2017/2018.

FUTURE OUTLOOK

If the foregoing points to the major challenges facing the country’s economic planners and decision-makers, we are nevertheless compelled to ask what goals we, as a society, seek to attain.

A successful economy must be built on a clearly formulated vision based on several general considerations, including the following seven points:

First, there must be a focus on attaining growth based on the development of human capacities, which means elevating education and occupational training to the highest priority for the government and society.

Second, there is a need to take advantage of the natural and capital assets of society so as to channel all the ingredients of production towards the realisation of higher levels of productivity.

Third, there is a need to realise the highest degree of fairness in the distribution of wealth through a just direct and indirect taxation system and an effective system for redistribution.

Fourth, there is a need to strengthen the role of government in supervising production so as to stimulate the investment cycle in a sustainable and flexible way, enabling support for beginning economic activity and for its continuity and growth.

Fifth, the private sector, civil society organisations, and companies must be regarded as primary partners in production, investment, employment and the export trade.

Sixth, the government, through its laws and regulations, should strive to stimulate research, development and invention both in education and in the production and service sectors.

Seventh, Egypt should strive to become a major economic player in the Middle East and Africa and in the Arab world in particular. It should also strive to take a dynamic role in the work and decision-making activities of international organisations, so as to become a partner in the global economy with a prominent role in forging new policies.

When broaching the issue of desirable economic policies, we also need to differentiate between policies affecting employment and investment and financial policies such as the national budget and monetary policies. Striking a balance between the design and management of policies concerned with the real economy and policies related to the financial economy is key to the success of a fully comprehensive reform process.

In this regard, coordinating between fiscal and monetary policy is an indisputable necessity. If fiscal policy inherently focuses on levels of national deficit and public debt with an eye to sustaining current social programmes that alleviate inequitable distribution while simultaneously stimulating the economy, monetary policy is primarily concerned with curbing inflation and price fluctuations. The primary aim of coordinating between the two is to bolster the real economy, namely investment, production, employment and the export trade.

We must also bear in mind the need to steer the country out of the current state of inflationary recession or “stagflation”. This means relatively weak economic growth rates and continued rises in the rate of inflation. Decision-makers should therefore attempt to identify the causes of the rising prices and remedy them; identify the sectors most harmed by the price increases and target them with measures to alleviate the strains; identify the sectors that can resume growth rapidly and focus on them in the short term; and identify new sectors that require attention and formulate policies to promote their growth.

Under the conditions of such inflationary recession, monetary policies should aim to deploy the necessary instruments to reduce prices, while fiscal policies should deploy instruments to promote economic activity, stimulate investment and reduce employment.

PRESENT REQUIREMENTS

With the above in mind, the following recommendations might be made:

- The government should direct the banking sector to gradually reduce interests rate in order to encourage investment;

- The treasury should stop issuing new money, thereby contributing to inflation;

- The government should introduce incentives to encourage small and medium-sized enterprises.

These incentives could include, first, making industrial and service sector land in existing and new industrial zones available to investors with usufructuary rights at competitive prices, so that small, medium and large investors starting economic activities will be inspired to begin at reasonable cost.

Second, a portion of the national budget could be allocated to labour-intensive public works projects (hydraulic, sanitation, electricity, canal maintenance, affordable housing projects, schools, roads and bridges, etc).

Third, the government should offer companies founded by direct foreign investors the same exemptions and incentives as those offered to Egyptian companies.

Fourth, certain areas should be designated “Golden Opportunity Investment Locations” and areas to which the government wants to attract investment, such as the North Coast, the Red Sea and some areas in Upper Egypt and the Suez Canal Development Corridor. Investment in these areas would be rewarded with financial and other types of benefits.

Fifth, in like manner, certain activities should be designated “Golden Investment Activities”, such as in the textile sector, the food production and processing sector, petrochemicals, fertilisers, iron and steel, pharmaceuticals, land reclamation, affordable housing projects, the construction of new schools and universities, and other areas that decision-makers regard as strategic.

Investment in at least some of these activities should be tax exempt, such as land reclamation and agricultural projects, or the construction of non-profit schools and universities, while reduced tax rates could be offered to other activities for specified periods of time.

Sixth, partnerships between the private and public sector in infrastructure construction projects should be encouraged. This could take place through the direct participation of companies from both sides, or through bonds put on sale to the public and repayable from revenues derived from fees or subscriptions to public-service projects.

The mechanisms that can be used to stimulate the economy and drive it forward are numerous. The sooner they are applied, the more effective they will be.

The writer is a professor of economics at Cairo University.

*This article was first published in Al-Ahram Weekly and will be published in the February issue of Egyptian Files by Al-Ahram Centre for Political and Strategic Studies.

 

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