Urgent economic reform in Egypt

Hussein Suleiman , Monday 28 May 2018

Reconciling macroeconomic pressures unleashed by the government’s economic reform programme will be one of the main tasks of President Abdel-Fattah Al-Sisi’s second term

File Photo: Nuts are sold at a market, ahead of the Muslim fasting month of Ramadan in Cairo, Egypt, May 6, 2018. (Reuters)

The Egyptian economy will face several interrelated challenges during president Abdel-Fattah Al-Sisi’s second term in office, many of them connected to changes precipitated by the government’s economic reform programme and the smaller role played by the state in the economy.

Egypt’s performance on key economic indicators will be among the foremost challenges during Al-Sisi’s second term, in view of the macroeconomic pressures unleashed by the reform measures put into effect in the second half of 2016. Reconciling these will be one of the government’s main tasks during the next four years.

Bringing inflation under control has been a priority. Immediately after the floating of the Egyptian pound in November 2016, inflation soared to unprecedented rates.

It was then exacerbated by successive rounds of subsidy reductions on various goods and services, most notably fuel and electricity.

The introduction of the new value-added tax (VAT), which took the place of the former 10 per cent sales tax, exacerbated the price hikes.

The inflation rate more than doubled from 10.2 per cent in 2016 to 23.5 per cent in 2017, the highest since the 1980s. In April, the IMF predicted that Egypt’s inflation rate would drop slightly to 20 per cent in 2018, but that it would not fall to 10 per cent before 2020.

In order to counter the inflation, the Central Bank of Egypt (CBE) raised its lending rate from 12.25 per cent in mid-2016 to 15.25 per cent in the immediate aftermath of the floating of the pound.

By mid-2017, it had reached 19.25 per cent. While raising the lending rate is the Central Bank’s main instrument for controlling inflation, it can have adverse effects on economic growth, as higher interest rates increase the cost of borrowing for both consumer and investment purposes.

The effect is to lower demand and hence reduce output, in the process slowing the rate of job creation. Unemployment has thus reached its highest levels in decades, ranging between 12.2 and 13.4 per cent over the past six years.

During Al-Sisi’s second term as president, the government will mostly likely try to reduce unemployment by stimulating growth.

However, the government faces a dilemma. Committed as it is to the economic reform programme, it cannot intervene directly to stimulate growth and thus employment.

Under the programme, the government is supposed to reduce the role it plays in the economy by cutting public spending, undertaking restructuring and reducing public-sector employment.

The private sector is expected to take the place of the state as the main driver of economic growth. But higher lending rates hamper investment and consequently the desired growth.

As a result, at the first sign of falling inflation rates in 2018, the CBE began to lower its lending rate, percentage point by percentage point, and it now stands at 17.25 per cent.

Clearly, it would like to reduce the rate faster, but doing so could send inflation rates up again, especially given inflationary pressures due to further anticipated reductions in energy subsidies and the possibility of adding a previously excluded bundle of goods and services to those subject to VAT.

Resolving the conflict between the need to reduce inflation by raising interest rates and the need to stimulate growth by reducing them will remain the government’s toughest macroeconomic challenge during at least the next two years. The way in which it manages it will to a large extent determine the performance of the Egyptian economy and the efficacy of the economic reform programme in remedying its structural flaws.

Social Challenges

Even before the economic reform programme went into effect, there had been a steady rise in the number of people below the poverty line. 

In 2000, 16.7 per cent of the population lived below the poverty line. Over the next 15 years, that rate gradually increased until, according to official figures, it reached 27.8 per cent in 2015 when 10 per cent of the population earned 48.5 per cent of the total national income.

The richest one per cent of the population received 19.1 per cent of total national income, while the bottom 50 per cent accounted for only 18.2 per cent.

Revealing as they are, these figures do not reflect the current picture or likely future trajectory, however. The figures come from 2015 before the beginning of the implementation of the reform programme and the subsequent inflation.

Given the heavy impact of this on the poor, especially in the context of growing income disparities, it is little wonder that inflation has been called “the cruellest tax of all.”

The purchasing power of the poorer segments of society is much harder hit by rising prices than that of wealthier segments that generally have incomes that buffer against inflation, such as interest-earning bank accounts or bonds with variable rates, making them better able to weather inflation than fixed-income sectors.

The wealthier segments are also in a better position to protect their wealth by converting local currency assets into real estate, gold or foreign currencies, thereby avoiding the loss of part of the value of their assets.

Such avenues are generally closed to the poorer segments of the population, whose assets are in the local currency.

The adverse social impacts of growing income disparities can have wider detrimental economic effects. With mounting poverty and income disparity rates can come social and political instability.

This feeds political uncertainty, which tends to repel investment and lower economic growth expectations. At another level, mounting economic inequality works to reduce overall demand for goods and services due to decreased consumption rates among the lower-income segments of the population, slowing economic growth.

As the direct role of the state in the economy recedes in tandem with the implementation of the economic reform programme, the social consequences of higher poverty rates and growing income disparities have greater chances of jeopardising growth and the success of the reform programme itself.

To avert such prospects, the government will need to increase social expenditure, while adhering to its explicitly stated goals of limiting public expenditure and reducing the deficit.

This compounds the complexities involved in striking an optimum balance between economic reform and the social responsibility of the state.

Institutional Challenges

As the state steps back in favour of the private sector as the main driver of investment, growth and employment, the government will need to perform its role as a market monitor and regulator, a guarantor of free competition and correct practices on the part of the private sector, and at times an active player. 

It will need to ensure a safe and equitable business environment for the private sector in order to win the confidence of investors.

Administrative corruption heads the list of institutional challenges that at present hamper private investment in Egypt. Since such problems increase the costs of founding and operating business enterprises of all sorts, they discourage investment.

According to the latest report by the NGO Transparency International, Egypt ranked 117th in its annual Corruption Perceptions Index (CPI).

The country’s ranking in this Index declined annually during Al-Sisi’s first term as president, but the rating still means that 68.2 per cent of businesspeople in Egypt see corruption as a main obstacle to their business.

In addition to corruption, the business climate faces other institutional challenges, most notably excessive amounts of red tape in order to establish and operate a business.

Egypt ranks 128th out of 190 countries in terms of the ease of doing business, according to the World Bank.

It also ranks poorly in terms of starting up businesses, registering real estate, tax treatment, ease of trade abroad, contract implementation and handling bankruptcy.

Institutional economic challenges extend beyond the laws and rules regulating investment practices and setting up businesses to the heart of the legal process, the rules of litigation, the relationships between government authorities, the jurisdiction and autonomy of regulatory agencies, as well as civil liberties, the protection of material and intellectual property rights, evasion of justice, the system of government, political stability and constitutional neutrality.

Such institutional frameworks and principles shape the overall investment picture for investors at home and abroad.

It tells them of their borrowing and investment prospects, whether they will have access to impartial courts to pursue their rights, whether they will need to pay incentives in order to run a business, and whether there is a risk of the arbitrary confiscation of their assets and other crucial factors.

The economic reform programme has added new variables to the economic picture in Egypt and aggravated already existing problems in the economy.

The inverse relationship between controlling inflation and stimulating growth has acquired a dangerous dimension due to the economic and social repercussions of the reform measures.

And the poverty and income disparity indexes are likely to climb to higher rates, which could jeopardise the ability to continue with the reform programme.

As for the institutional context, upgrading and streamlining is essential in view of the fact that the state is playing a more limited role in the economy and the need to lure further private investment to stimulate growth and job creation.

The writer is a researcher in economics at the Al-Ahram Centre for Political and Strategic Studies.


*A version of this article appears in print in the 24 May 2018 edition of Al-Ahram Weekly under the headline: Urgent economic reform 

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