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Al-Ahram Weekly 27 April - 3 May 2000 Issue No. 479 
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Published in Cairo by AL-AHRAM established in 1875 |
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Al-Ahram Weekly 27 April - 3 May 2000 Issue No. 479
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| Published in Cairo by AL-AHRAM established in 1875 |
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Egypt Region International Economy Opinion Culture Special Features Travel Living Sports Profile People Time Out Chronicles Cartoons Letters From reform to recession
By Ibrahim El-Essawi *
Not so long ago, government officials as well as many liberal economists and politicians were boasting tirelessly about the success of Egypt's economic reform programme, which started in 1990. Financial rather than real-growth indicators were often cited, including bringing inflation down to four per cent and the budget deficit to one per cent of GDP, and accumulating foreign reserves, which at one time exceeded $20 billion. Low GDP growth rates, rising unemployment, a mounting trade balance, increasing domestic public debt, poverty, maldistribution of income and wealth and other embarrassing indicators were readily dismissed as no more than temporary side-effects of the reform medicine, or the passing ailments of a recovering economy.
Optimism about the prospects of the Egyptian economy was frequently reinforced by "good conduct" and "good rating" certificates issued by a variety of international financial institutions. As of 1996, the Egyptian economy was supposed to move from a phase of stabilisation and structural adjustment into a phase of vigorous growth. Hence the adoption of a package of growth-stimulating measures in 1996 and the simultaneous and hasty launching of the so-called mega national projects in 1997, of which the most prominent was the new delta development project in Upper Egypt, whose economic credibility was never convincingly established.
Nevertheless, growth appeared to be more elusive than ever, and poverty and unemployment remained at distressing levels -- that is, when they did not increase. Moreover, the goals of successive development plans turned out to be mere wishful thinking unrelated to the realities of the economic situation. Even the new development plan for the financial year 2000/2001 appears at variance with the current language of both the government and the business community.
Today, government and business circles are speaking of a "liquidity problem," and even of "recession". Liquidity shortages, once a short-term problem (which is by no means abnormal in the running of business or government affairs, given the inevitable lack of harmony between receipts and payments over time), have become a chronic problem of increasing magnitude. While spending continued at rapid rates, revenues were hard to come by. Therefore, liquidity shortages lingered and grew disproportionately out of hand. Consequently, a serious debt problem emerged for the private and the public sector as well as for the government, due to heavy borrowing from banks. Therefore, debt service allocations are now absorbing a good part of the budgets of both business enterprises and the central government (25 per cent in the new budget proposal). With this heavy burden, further borrowing becomes more difficult and more costly, and allocations for investment and output growth severely inadequate, not to mention allocations for social services and poverty alleviating measures. In short, the economy is being trapped in a recessionary spiral.
Ironically, some of the measures that were initially intended to revive the economy are now blamed for the liquidity problem and the resulting stagnation. In particular, the mega investment projects in Upper Egypt, north Sinai, the Gulf of Suez and east Port Said are pointed to as a major cause of the problem. Such blame is not unjustified, given the fact that a good part of the construction works were implemented by public and private companies in response to governmental commands, with promises to pay later. But such promises were hard to fulfil, and the companies concerned were forced to overborrow from the banks.
To be fair, the foregoing is only a small part of the explanation of the Egyptian economy's current stagnation. In fact, it has been a long-standing tradition for the government to be indebted to construction and other companies for public works and other governmental projects. The Arab Contractors Company -- the biggest in its field in Egypt, with a turnover of nearly LE5 billion in 1998 -- is a case in point. This company implements a good chunk of infrastructure and other projects for the government. Its financial statement for 1998 shows that it was in the red to the amount of LE2.4 billion (i.e. half of its turnover), and paid interest on its bank loans amounting to LE260 million, which sharply contrasts with a net profit of LE100 million. The company's clients, of which the government is probably the biggest, owed it LE2.3 billion (a figure very close to its bank debts).
Therefore, other factors must be invoked to explain the awkward state of the Egyptian economy. They include four major factors:
SWELLING PUBLIC DEBT: The domestic public debt was officially estimated at LE147 billion at the end of the financial year 1998/99, registering a 53 per cent increase over its 1993/'94 level and accounting for 49 per cent of GDP. If the external debt, which showed a modest decline over the 1993/'94 - 1998/'99 period (from $31 to $28 billion) is added, the total public debt reaches LE243 billion and accounts for 80 per cent of GDP in 1998/'99. Although the public debt reinforces aggregate demand by maintaining a high level of government spending, the mechanism is defective for several reasons. First, its cost is exorbitant. It amounts to LE27.6 billion in the budget proposal for the financial year 2000/2001, which is nearly equivalent to expected direct taxes (LE27.8 billion). Second, although so far non-inflationary, keeping public spending at such high levels without corresponding increases in public revenues is bound to generate inflationary pressures sooner or later. Needless to say, the rising public debt is symptomatic of a chronic governmental failure to collect taxes, which are outstanding at LE17.6 billion -- a figure slightly smaller than that for public expenditure on education (LE18 billion), and 17 per cent higher than that for public spending on health services, cultural, social and religious services, and all kinds of subsidies in the budget proposal for the coming fiscal year (LE15 billion).
INJECTIONS AND WITHDRAWALS: A rise in government spending is an injection into the circular flow of income, which is bound to cause a series of successive, but diminishing, increases in GDP. The sum of the latter is normally greater than the initial rise in government spending, and its ratio to the initial rise in spending is called the multiplier. Higher multipliers (a good thing in times of slumps) imply that a good portion of the increases in GDP is being spent within the economy, and that income withdrawals or leakage (e.g. through savings, taxes and imports) are small. The biggest single leakage in the Egyptian economy is imports, since both savings and tax receipts are rather modest. A high propensity to import raw materials, intermediate and capital goods, and consumer goods tends to depress the multiplier and thereby much of the impact of the initial rise in government spending is dissipated and causes serious balance of payments problems.
According to the Central Bank of Egypt, imports of goods reached $17 billion (slightly less than four times Egypt's exports of $4.4 billion) in 1998/'99. This contrasts with the situation five years ago, when imports reached $10.6 billion (slightly less than three times the value of exports: $3.3 billion). This reflects the high import content of domestic spending on consumption, investment and production, and a very weak capacity for exporting manufactured goods. The high propensity to import is largely attributable to a structure of industrial production based on import substitution, which ironically calls for an excessive volume of imports not only of capital goods, but also of intermediate goods and raw materials. Likewise, most infrastructure works and the mega-projects entailed enormous imports.
EXCESS SUPPLY OF CONSUMER GOODS AND NONTRADABLES: The Egyptian market has witnessed a massive growth in the supply of consumer goods in recent years. This growth was fuelled by two factors. One is the current incentives system, which is fairly generous and does not favour specific lines of production. Under such conditions, investors are attracted to the easiest sectors, namely assembly production of all sorts of consumer durables and nondurables. Initially, the market's capacity for absorbing such goods was large, and producers earned respectable profits. Over time, however, many investors were tempted to enter this market, and saturation levels were rapidly approached, leading to high inventory and idle capacity levels, and consequently severe liquidity shortages. Second, excess supply of consumer durable and nondurable goods was generated through a high level of imports. These were the result of several factors, including liberalisation of foreign trade, tariff reductions, ease of evasion of import duties and widespread smuggling (which reached outrageous levels in the case of textiles and garments). Finally, more recently, the southeast Asian crisis of 1997, which resulted in sharp reductions of exchange rates and prices, encouraged importers to import huge amounts of goods -- so huge that they would keep the market well supplied for two or three years. Here again, inventory levels soared, and lack of liquidity cropped up, causing acute insolvency problems, particularly vis-à-vis the banks.
A similar situation emerged in the production of non-tradables, especially the real estate market. Housing shortages, easy borrowing from commercial banks, investment incentives in the new cities, and partial liberalisation of the housing market encouraged growth of supply of residential and non-residential buildings, in both densely populated areas and the new cities. Being largely driven by market forces, investors invested heavily in luxurious units. However, given the limited size of the upper and upper-middle classes in Egypt, the market was soon saturated. Nevertheless, prices proved so rigid that market clearance became impossible, leading to liquidity shortages, insolvency problems, and recessionary pressures.
EFFECTIVE DEMAND SHORTFALLS, POVERTY AND INEQUITY: Any explanation of the recession will be incomplete if the question of income adequacy, income distribution and poverty is ignored, for the limited absorptive capacity of the Egyptian market is primarily the product of gross and growing inequities in the distribution of income (the ratio of the income share of the richest 20 per cent to the poorest 20 per cent of the population was 4.4 in 1995/'96), and a strong incidence of poverty (with 48 per cent of the population earning incomes below the poverty line in 1995/'96). Other factors contributing to the shrinkage of purchasing power include the reallocation of private expenditure away from consumer goods, and towards education and health expenses on account of reduced subsidies to the social sectors, expansion of cost-recovery programmes, and the consequent rise of the proportion of household income allotted to private tuition and private health care. Unemployment, stagnation and even regression of public sector enterprises due to a prolonged lack of investment and ambiguous policy regarding their privatisation are also relevant explanatory factors for the recession.
It is open to question whether the injection of $1 to $2 billion per month, as envisaged by the government, would be adequate or even safe for a healthy recovery of the economy. In fact, the risk of moving from stagnation to stagflation (i.e., stagnation with inflation) should not be overlooked. More importantly, however, a proper treatment of the current dilemma must start with a recognition of the point which the preceding analysis tried to stress: namely that the roots of the predicament lie deep in the structures of investment and production, in current industrial and trade policies, the pattern of income distribution and poverty-generating forces, and the lack of a proper mix between market forces and planning.
* The writer is professor of economics at the National Institute of Planning and principal investigator of Project Egypt 2020.
