The United States credit downgrade has shocked the global economy with policymakers, analysts and business leaders contemplating the possiblilty of a global economic meltdown similar to the 2008 crisis with grave implications for countries across the world. 

Ratna Sahay, deputy director in the IMF's Middle East and Central Asia Department, shares her insights on the future of the Egyptian economy and its ability to grow, create jobs and meet budget targets amid global economic turbulence.

Ahram Online: How realistic is Egypt's budget revenue and spending targets if a world crisis hampers growth in Egypt’s economy?

Ratna Sahay: It is too early to comment on the impact of the current global financial turmoil on the world economy or Egypt. But a lesson learnt from the 2007-2008 crisis as well as from post-revolution developments is that the prospects of the Egyptian economy and the fiscal outcome depend much more on domestic political developments and domestic fiscal policy.

Indeed, despite the fact that global growth at that time slowed by about six percentage points in two years (as compared to pre-crisis projections), the Egyptian economy slowed by only 2.5 percentage points. This was due mostly to the limited financial linkages Egypt had with the rest of the world.

The main spillovers came from the economic slowdown in trading partners in the form of fewer tourist arrivals, slower Suez Canal traffic, and lower exports. Regarding the fiscal deficit, most of the widening was due to actions of the government to stimulate the economy, rather than from automatic declines in revenues or a rise in spending due to the cyclical downturn. 

Can local consumption carry the Egyptian economy should world demand plunge?

Yes, in fact that is exactly what we observed after the global financial crisis of 2007-08. In the face of a decline in tourism receipts, Suez Canal traffic and capital inflows (especially foreign direct investment), it was domestic demand (especially consumption) that helped mitigate the negative spillovers of the crisis. Real GDP growth in Egypt was much higher than comparable emerging market countries during 2009 and 2010.

In the coming months, Egypt will likely face both considerable political uncertainty and negative external shocks if external demand weakens. Under these circumstances, a smooth political transition and sound policies will go a long way in reducing the risk premia for domestic and foreign investors, bringing tourists back, and building consumer confidence to mitigate the impact of any slowdown in the global economy.

Given already low growth targets, how do you see the Egyptian economy's job creation ability?

Addressing the issue of job creation should be a top priority for the Egyptian government.

Unemployment has already grown from below nine per cent in December 2010 to nearly 12 per cent in March this year — youth unemployment is even higher. According to our studies, to absorb the new entrants alone into the labour force, real GDP needs to grow at seven per cent per annum. However, the target GDP growth could be lower if it is more employment-intensive.

Given its many strengths — a diversified and large economy, a vibrant young labour force, and a privileged geographical location for trade and tourism — Egypt’s job creation ability is high. These need to be leveraged by improving the business environment, especially for small and medium sized enterprises, providing equal opportunities for all sections of the society, and creating a more transparent and competitive economy.

Indeed, these reforms are no different than the popular demands on the streets of Cairo. Since employment creation will be limited in the short run, some mitigating immediate measures may be needed to protect the most vulnerable.

What policy direction should the Egyptian government take to minimise the negative effects of a possible world economic crisis?

The sharp worsening of the fiscal balance and the slowdown in economic growth in Egypt in the recent past was not directly caused by the 2007-08 global financial crisis. Instead, their roots lie in regional and domestic political turmoil since early this year and a spike in international food prices. In some ways, this is good news as it means that reviving the Egyptian economy through appropriate policies is very much in the hands of the government.

On the fiscal side, it would be important to ensure that as revenue declines with the slowing down of the economy, tax evasion is minimised. Additional social transfers should be provided to the most vulnerable as they are more significantly affected by a downturn. The scope for fiscal expansion, however, is becoming increasingly difficult, given the financing constraints.

On monetary policy, the central bank should maintain a flexible exchange rate that reflects the underlying forces of demand and supply, while avoiding excessive day-to-day volatility.

Finally, the reforms I had mentioned earlier to support employment-intensive growth will also enhance productivity and strengthen the competitiveness of the Egyptian economy.