Discrepancies of reform

Despite praising the capabilities of Egypt's new economic team, a report sees testing times ahead, writes Wael Gamal

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The appointment of the new government in July seems to be the most important development cited by the new Economist Intelligence Unit report on Egypt released recently. The speed and scope with which the economic reform programme has taken place caught the report by surprise. However, while the report shares with the Egyptian business community its enthusiasm, it is not blinded by it.

The report goes through the new measures which include lowering customs duties; simplifying customs procedures; tax reforms which substantially reduce personal and corporate tax rates; raising the tax threshold and reimbursing sales tax charged on capital goods; reduction of diesel subsidy; and the reinvigoration of the privatisation programme.

Government's calculations are that the short-term cost in terms of lower revenue will in the medium term be more than recouped by a widening of the tax net, as the incentive to evade is reduced, and a more rapid pick-up in economic activity, which will both raise the tax take and reduce pressure on government spending.

Such a goal should be facilitated as consumer and business confidence strengthens, boosted by the more coherent economic management now in evidence. The pick-up in privatisation should also strengthen Egypt's ability to finance its fiscal deficit. While lowering customs tariffs is likely to stimulate economic activity, raising consumption, investment and output and therefore income tax and customs revenue.

However, as a result, at least in the short-term, the overall deficit is expected to rise sharply from an estimated 6.1 per cent of GDP in fiscal 2004 to 8.7 per cent of GDP with domestic debt-servicing commitments rising strongly, lifted largely by growth in the debt stock. Arresting this deterioration in public finances is considered the main challenge to the new government in addition to "bringing greater coherence and transparency to monetary policy and the management of the exchange rate, tackling rapidly rising inflation and raising extremely low business confidence".

Nevertheless, the EIU raised its projections for economic growth during 2005 and 2006 compared to the previous report. "Overall, growth is forecast at 3.5 per cent and is expected to rise to 4.7 per cent in fiscal 2006."

Official figures published by the Central Bank of Egypt (CBE) put real GDP growth at 4.4 per cent in fiscal 2004 (1 July 2003-30 June 2004), up from 3.1 per cent the previous year. The government is projecting 5.5 per cent growth in fiscal 2005 and aims to raise expansion six or seven per cent over the next four to five years. The rate is considered necessary to absorb the 600,000 or so new applicants to the job market each year and to make at least a dent in unemployment; thereafter officials speak of targeting growth of nine to 10 per cent.

The EIU does not share the same projections of the government because "the strongly projected rise in imports, stimulated by the reduction in duties and the declining expansion of government consumption, is seen as constraining growth in the short term."

The report points to improved confidence in the convertibility of the currency and the growing stability of the pound exchange rate but it also indicates that the new government is yet to clearly lay out its exchange rate policy. In the absence of signs to the contrary, it seems likely that the government will persist with its current policy of a steady depreciation of the pound. The report forecasts that the pound "will fall to LE6.48 per dollar by the end of 2005, a decline of 3.7 per cent compared to the end of the 2004 rate, and to LE6.76 per dollar by the end of 2006, a fall of just over four per cent".

The report approves the economic rationale behind the reform programme in the broader sense. However, it is alert to the risks of the cabinet's bold approach. "If commitment to reform flags, economic activity may not strengthen sufficiently, and privatisation may not accelerate enough to offset revenue shortfalls, leaving public finances in a more precarious state.

"Moreover, if tourism, Egypt's main industry, suffers a sharp downturn, the government's task will be made more difficult. At this stage, the attacks in Sinai in October seem unlikely to have a severe impact on the industry but any other incidents almost certainly would," the report warns. Also, the reform process unveiled will ultimately involve measures that carry a social cost, constituting another challenge which could be fatal to the whole process of reform.