Egypt's economy: Ongoing challenges

Sherine Abdel-Razek , Wednesday 31 Jul 2019

The IMF said it is happy with the results of the government’s economic reform programme, but limited foreign investment and increasing debt are problems still facing the economy, writes Sherine Abdel-Razek

source: Deutchs Bank

The International Monetary Fund’s (IMF) board voted to disburse the final $2 billion tranche of its $12 billion loan to Egypt last week after measures introduced under the deal, agreed in November 2016, had included a sharp devaluation of the pound, deep cuts to energy subsidies, and the introduction of a value-added tax (VAT).

“The macroeconomic situation has improved markedly since 2016, supported by the authorities’ strong ownership of their reform programme and decisive upfront policy actions,” David Lipton, acting IMF managing director and chair of the board, said in a statement.

The government’s critical macroeconomic reforms have been successful in correcting large external and domestic imbalances, achieving macroeconomic stabilisation and recovery in growth and employment, Lipton said. 

Egypt has achieved a growth rate of five per cent on average during the last two years compared to an average of two per cent prior to the agreement. This has helped in creating jobs in a way that has helped to reduce the unemployment rate from 13 per cent in 2013 to eight per cent currently. 

“The elimination of most fuel subsidies, which are regressive, will encourage energy efficiency, help protect the budget from unexpected changes in oil prices, and free up fiscal space for social spending,” Lipton said.

Last month, Egypt introduced its fourth fuel price increase since the agreement with the IMF was reached, cutting energy subsidies in the current year by $37 billion to reach $53 billion. 

The increases range from 17 per cent on the highest-grade of unleaded 95 fuel used by high-performance and luxury cars to 30 per cent on the liquid gas canisters used by many households for cooking. 

Both diesel, a fuel widely used by trucks and buses, and gasoline 80, used for heavy transport vehicles and agricultural tractors, saw prices increase by 22.7 per cent. The move meant that the government is no longer subsidising this fuel segment, while diesel and liquid gas canisters are still 40 per cent subsidised. 

The IMF also praised Egypt’s achieving a primary budget surplus, the difference between all government revenues and expenditures excluding interest payments on debt, of two per cent in 2018. This will “help to anchor a further decline in the public-debt-to-GDP ratio. It will be important to maintain primary surpluses at this level over the medium term to keep public debt on a downward trajectory,” Lipton said.

While faring well on many levels, Egypt’s transactions with the rest of the world as translated in its current account balance are still worrisome, however. Fitch, an international ratings agency, expects the current account deficit to increase to 2.8 per cent of GDP in the current fiscal year compared to 2.5 per cent last year. The deficit is being fed by a growing trade deficit due to limited export growth and rising imports. 

The current account deficit narrowed significantly between 2016 and 2018 as remittances increased and tourism revenues recovered. However, over the past year, it has widened rapidly, increasing from $493 million in the fourth quarter of 2017-2018 to $3.75 billion in the third quarter of 2018-2019.

While hydrocarbon production growth will slow down in the coming year and thus affect exports, Fitch said, it also expects non-oil exports to grow considerably more slowly in the coming fiscal year. Egypt’s non-oil exports grew by a mere 0.3 per cent year-on-year in the first quarter of 2019.

“We see little scope for this to turn around in the near term in the light of a strengthening Egyptian pound (which we believe will continue in the second half of 2019) and softer demand from key trade partners such as Germany, Italy and China,” Fitch said.

Moreover, despite the fact that Egypt is importing less fuel, its over-reliance on imported goods negates the possibility of an improvement in the trade balance soon. The improvement in tourism and remittances inflows could help to mitigate the effects of the rising trade deficit, however.

“Tourism receipts are now nearly at their pre-Arab Spring levels, after being buffeted by social instability and terrorist attacks for the better part of the last decade,” Fitch said.

“Workers’ remittances, another crucial source of hard currency inflows, should pick up as well, in tandem with stronger real GDP growth in the Gulf Cooperation Council, which we forecast will average 2.2 per cent in 2019 and 2.9 per cent in 2020, from two per cent in 2018,” it added, referring to the GCC group of oil-producing Gulf nations. 

These factors should help keep Egypt’s current account deficit below its recent ten-year average of four per cent of GDP.

However, with limited foreign direct investments (FDI) being channelled into the country, Egypt will need to fund this deficit through more borrowing from abroad. Non-oil inflows of FDI fell to five-year lows of $400 million in the first quarter of 2019. 

Underscoring this problem, an opinion piece written by economist Amr Adly for the US outlet Bloomberg recently warned of declining ratios of FDI to GDP, in contrast with increasing ratios of foreign debt to GDP and total exports in four Arab nations, including Egypt.

“Growth through debt rather than investment will have a long-term negative and unsustainable impact on the ability of these nations to develop their economies. They will have a hard time servicing their external obligations and will likely miss opportunities for attracting badly needed foreign investments for growth and employment generation,” Adly said.

In Egypt, the ratio of external debt to Gross National Income (GNI) more than doubled from 17 per cent in 2010 to 36 per cent in 2017. 

The ratio of external debt to the total exports of goods, services and primary incomes was even more dramatic. Between 2010 and 2017, it increased from 75 to 190 per cent, exceeding the 77 per cent limit at which, in the World Bank’s reckoning, foreign debt starts having a negative impact on growth.

Last week, it was revealed that the government was trying to attract $5 billion of foreign investments in the automotive sector over the next two years. 

Two government sources told the Enterprise online news website that this was part of a plan to develop the sector by growing local car assembly and manufacturing through a package of incentives revealed last month. 

The proposed incentives programme could see the finance and trade ministries provide custom breaks to local assemblers and manufacturers that use at least 45 per cent of local components.

Interested companies include the US-based Ford company and the Japanese manufacturers Toyota, Suzuki, Nissan and Isuzu.

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