The cost of asking for a revolution

lahcen Achy , Monday 7 Feb 2011

As demonstrations force Egypt to undertake political reforms, the economic cost of the turmoil can also be met by the policies of a credible government

The nationwide demonstrations in Egypt that erupted on 25 January are likely to last in the absence of a middle ground alternative out of the impasse between the regime and protesters. The political ramifications of the unrest are deep and substantial and could transform modern Egypt forever. Such an outcome comes at a significant cost in the short term. Economic growth is projected to decline, job losses and poverty to increase, inflation to heighten and the budget deficit to expand. If mass protests continue for several weeks, the damage may be considerable. If, instead, a smooth transition takes place and the right reforms are implemented, the hardship can be offset and positive effects on the Egyptian economy are likely to be seen in the medium and long term. 

The social upheaval has disrupted production and service provision, spread fear among tourists who left the country or decided to cancel their planned trips to Egypt, and forced investors to reallocate their portfolios away from Cairo’s stock market to safer destinations.

The government decision to cut off mobile phone and text-messaging, deny access to internet and block rail and roads links to Cairo has worsened the situation. Most shops and markets have been closed. Subsidized bread, milk and other basic food commodities have been lacking on the shelves. The disruption in supply and distribution pushed prices up and further eroded the purchasing power of wide segments of the population. The price of food items, which consume 45 per cent of the average family budget, soared by more than 15 per cent.

Tourism, which provides more than two million jobs and around of 10 per cent of the country’s economic output, has suffered from the social uprising. Many Egyptians who depend on tourism, directly or indirectly, for their living are at risk of falling into poverty and deprivation.  Hotels are empty and international tour operators have stopped offering Egypt as a destination. Estimates indicate that Egypt has been losing one hundred million dollars a day in tourism since the popular uprising began. The sector stands as the first source of foreign currency, bringing in more than $10 bn on average over the last three years. Before the riots erupted, tourism was projected to provide more than $14 bn during the fiscal year 2010-2011.

On the financial side, Egypt’s stock market plunged by 21 per cent since early January. It lost 16 per cent of its value in two days after mass demonstrations in Cairo’s Tahrir Square began and has been closed for more than a week with no date set for its reopening.  Foreign holding represents 22 per cent of the Egyptian stock market assets, of which 7 per cent are held by Arab investors. High uncertainty will lead to massive reallocation of flows of foreign portfolio investments from Egypt to alternative markets. In addition to their harmful effect on the stock market, large outflows may put serious pressure on the Egyptian pound, weaken foreign exchange reserves and increase the risk of an external payment crisis. The Egyptian pound, which is entirely convertible, has fell to a six-year low against the dollar at the start of the protests — LE5.855 pounds per dollar – before the government closed banks and stopped any foreign exchange transactions.

In normal circumstances, Egypt's central bank tightly manages the pound’s movements against the dollar to preserve its stability. If it faces a rush of currency withdrawals, the central bank may fail to keep the pound stable. The French bank, Credit Agricole, expects the pound to depreciate by up to 20 per cent over the short term.

Banks have been closed for days and may face liquidity problems as they resume business. Fearful of another extended closure, account holders could take out large amounts of their cash. To prevent such behavior, the central bank has decided that customers cannot withdraw more than LE50,000 and $10,000 a day.

Egypt’s sovereign credit-rating was downgraded by international rating agencies. This move will increase the cost of debt for Egypt. The cost of insuring Egyptian debt against default jumped after demonstrations began to an eighteen months high. The five-year credit default swaps (CDS) have risen to a maximum 430 from 320 basis points. It fell to 360 bps as there is no immediate risk of insolvency. The external debt in Egypt represents 15 per cent of GDP and most of it is made up of long term debt.


The Challenges Ahead

Major economic challenges and deep social imbalances will need to be addressed in the forthcoming years. In the short term, however, the priority is to return to “normal” economic activity with a credible roadmap for political transition.

From an economic point of view, the priority will be to restore confidence. The government in charge of managing the transition will need to send strong signals to domestic and foreign investors that Egypt is heading towards a stable, transparent and competitive business environment. With confidence, tourists will come back to the country, outflows of foreign exchange reserves will stop and economic growth resume.

In the medium term, the elected government will need to refocus on social issues by fighting poverty and inequality and stimulate the creation of decent jobs.

Today, more than 40 per cent of Egyptians earn less than two dollars a day and large inequalities exist between rich and poor. Two key pillars need to be activated. First, Egypt will need to reform its taxation system, crack down on tax evasion and adopt a progressive and redistributive taxation scheme. Second, Egypt must revisit its universal subsidy system that absorbs more than eight per cent of GDP and over one third of public spending. Though politically popular, available studies show that the benefits of non-targeted subsidies accrue to the rich more than the poor. To mitigate the impact of dismantling universal subsidies on the poor, Egypt needs to increase the minimum wage in both the government and the private sector and implement appropriate safety net mechanisms. Finally, policy-makers should shift fiscal resources saved from subsidies to public investments in health, education and employment policies. 

The writer is a senior economist at the Carnegie Middle East Center

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