Raining on the reform parade
Although the government paints a rosy picture of economic growth, Sherine Abdel-Razek
finds out it's no good, if it's not sustainable
Listening to statements by cabinet members about the state of the economy, one would think Egypt was living an economic dream. Prime Minister Ahmed Nazif's government has taken to boasting a series of economic accomplishments, which include a 7.1 per cent growth rate in the first half of 2007 and soaring foreign direct investments (FDIs) which reached $6.1 billion in 2006, up from just $300 million in 2004. Completing the list of achievements is record tax revenues and a buoyant privatisation programme which added LE33.4 billion to government coffers. Meanwhile, a rise in investments coupled with tax reductions increased disposable income, which in turn boosted consumption. Also, trade is being liberalised with tariff reductions and the performance of local bourses has become the envy of many developing economies. Egypt, among other six countries, was selected as the top reformer of investment climate and business environment by the Economic Reform Forum for their reform procedures. Egypt was the only country in the Middle East and North Africa region to be selected by the forum, affiliated to the World Bank and co-sponsored by the International Finance Corporation (IFC).
But according to a series of recent local and international reports, it's all too good to be true. While unanimously acknowledging sound economic performance and positive advances in different sectors, the reports issued throughout this month are sceptical as regarding the sustainability of this growth, in view of currently implemented monetary and fiscal policies. In other words, escalating inflation rates, coupled with the government's reluctance to increase interest rates or cut subsidies might turn the dream into a nightmare.
These factors are putting Egypt in the 65th position out of 128 countries included in the Global Competitiveness Index. According to the most recent Global Competitiveness Report (GCR) released by the World Economic Forum, Egypt's competitive potential remains under-utilised. A major shift in macro-economic management could contribute to enhancing growth, including prudent public spending to rein in one of the highest budget deficits in the world (ranking 127 out of 128 countries), and limit the government's soaring debt (ranking 104 out of 128 countries). Inflation is also surprisingly high given the worldwide trend towards increased price stability.
Looking at the flip side of the coin, all reports warned that the government's most prized achievement of high growth rates is not necessarily a good thing, because growing too fast is not always the best course to take. "All countries aspire to achieve faster growth, but the question of sustainability is as important as the rate of employment and income growth," noted a Morgan Stanley report. "After all, boom-bust growth cycles lead to underperformance in the long run and hurt the poor more than others."
After growing at an average annual rate of 4.4 per cent in the 1990s, real GDP is witnessing an unprecedented increase over the last two decades which is well above the sustainable growth rate. One of the reasons behind Egypt's low ranking in the GCR report is that economic reform has lacked continuity over the years. "It picked up momentum in the early and mid-1990s, but then slowed [until 2004], eroding some earlier successes," GCR stated.
The short-lived reasons behind the growth explain the surge in consumption and core inflation. These include the fact that growth is supported by recent hikes in petrodollar liquidity and low interest rates; a sharp increase in bank lending to the household sector, growing at an annual rate of 25 per cent (from four per cent in 2002); and an unprecedented boom in the real estate sector.
Inflation topped the list of challenges highlighted by the reports. Measured by consumer price index (CPI), inflation increased at an annual rate of 12.8 in March, 2007, compared to 12.4 per cent at the end of 2006 and 3.1 per cent in 2005. This was fed by higher food prices -- representing 38 per cent of the CPI -- and a reduction in energy subsidies, which increased the burden on the fuel-sensitive housing and transportation sectors. An HC Securities report cites the appreciation of the euro against the Egyptian pound, together with an increase in disposable income due to tarnishing tax rates and a faster growing economy, as the main culprits of inflation.
However, the Morgan Stanley document viewed the problem in a different way. "Egypt's inflation problem is not just about one-off developments, but really stems from loose macro-economic policies that have led to overheating of the economy," it explained. "Administrative measures may stabilise inflation, but will not address the underlying problem." The report continued that the expansionary policy stance -- negative real interest rates (inflation rising faster than interest rates), coupled with a large budget deficit -- is the real problem and results in unbalanced growth and inflationary pressures.
In the face of an almost nine per cent increase in inflation rates since the end of 2005, the Central Bank of Egypt (CBE) increased interest rates by only 0.75 per cent during 2006, and left it the same in 2007. "We believe the rise in interest rates was lower than one might have expected as a result of flaws in the inflation indices, and that inefficiencies in the monetary [policy] mute the impact of a rise in interest rates," commented EFG-Hermes' Egypt's Year Book 2007.
Inefficient monetary policies were also highlighted by Morgan Stanley, stating that even though CBE acknowledges the need to normalise negative real interest rates, monetary tightening is not easy with Nazif's heading of the Coordinating Council for Monetary Policy, where politicians have more weight than central bankers. "When politicians get involved, monetary policy tends to become less effective," the report argued.
In addition to expansionary monetary policy, another shortfall of the government in dealing with this problem is the introduction of administrative fiscal policy-related measures, aimed at increasing revenues. These include imposing export tariffs on steel and cement, a move that contradicts the spirit of the reform agenda and does not really address underlying imbalances in the economy, according to Morgan Stanley. To deal with the fiscal imbalance, the government should either lower its subsidies or increase borrowing and push domestic debt further. Other expenses, like wages, salaries and expenditure on health and education, are hard, if not impossible, to lower.
The HC Securities report believes that dealing with this problem puts the government in a catch-22 situation. "Lowering or eliminating subsidies would put immediate upward pressure on inflation, whereas further borrowing and thus greater future interest expenses, create the burden of finding future revenue," it explained. "Should that revenue fail to materialise, the potential inflation risks are even greater."
It is noteworthy that the consolidated fiscal deficit of the general government was reduced from 8.9 per cent of GDP in FY05 to eight per cent of GDP in FY06. This decline is mainly attributable to a combination of robust GDP growth and large privatisation proceeds, namely LE5.9 billion out of the LE16.7 billion earned through the sale of Egypt's third mobile licence. But these one-off items will not sustain the decline in deficit parentage to GDP.
Another persistent problem distorting the bright picture painted by Nazif's cabinet is unemployment rates. While official government figures show that in FY05/06 unemployment decreased to 10 per cent, from 11.2 per cent the previous year, the rate of job creation in Egypt currently lags behind population growth, suggesting a potential future crisis. HC Securities points out that the severity of this problem can be seen by comparing labour force figures to demographic data. In FY05/06, the labour force stood at 30.6 per cent of the total population, as opposed to 30.3 per cent in FY05. However, 32.6 per cent of Egypt's population is under the age of 15.
Can Egypt overcome this obstacle? "Egypt is betting that it can overcome this challenge and others like it," responds the HC Securities report, "even while such problems make up the very thread of Egypt's economic fabric."