Friday,20 July, 2018
Current issue | Issue 1308, (18 -24 August 2016)
Friday,20 July, 2018
Issue 1308, (18 -24 August 2016)

Ahram Weekly

The cost of austerity

An IMF loan will help get Egypt’s macroeconomic indicators in shape, but other factors must be in place before there is a full turnaround of the economy, writes Niveen Wahish

Al-Ahram Weekly

“Egypt is a strong country with great potential, but it has some problems that need to be fixed urgently,” Chris Jarvis, the International Monetary Fund (IMF) mission chief for Egypt, said in a statement last week. He was announcing that the country had reached a staff-level agreement with the IMF on a three-year US$12 billion Extended Fund Facility (EFF) loan, which should be approved by the organisation’s executive board in the coming weeks.

The urgency of the loan cannot be highlighted enough. Hard currency reserves with the Central Bank of Egypt (CBE) stood at US$15.53 billion at the end of July, less than three months’ worth of imports and with no prospect of quick replenishing.

Tourism revenues are not expected to exceed US$4.5 billion this year, almost a third of the record in 2010. Suez Canal revenues are at an annual average of around US$5 billion, with the global slowdown in trade preventing any significant surge. Exports are down, with the ministry of finance reporting US$13 billion in revenues for the first three-quarters of 2015-16, compared to US$17 billion for the same period the previous year.

“The EFF supports the authorities’ comprehensive economic reform programme, as stated in the government plan approved by parliament,” Jarvis said following the two-week visit of an IMF team to negotiate the loan with the Egyptian government.

The government programme will include fiscal and monetary policy reforms, structural reforms and measures for social protection. One of the targets of the programme will be to place public debt on a declining path. “Over the programme period, general government debt is expected to decline from about 98 per cent in 2015/2016 to about 88 per cent of GDP in 2018/2019,” Jarvis said.

The country’s budget deficit also needs to be narrowed. Ministry of finance indicators for July 2015 to May 2016 point to the budget deficit reaching 11.2 per cent of GDP compared to 10.8 per cent during the same period the previous year.

“Sooner or later Egypt was bound to take a loan from the IMF,” former finance minister Samir Radwan told the Weekly, adding that “there is a clear funding gap that was not on its way to being closed soon.”

When in office in 2011 Radwan negotiated a US$3 billion loan with the IMF, but the Supreme Council of the Armed Forces (SCAF), in charge of the country following the ouster of former president Hosni Mubarak, decided not to take the loan in order not to burden future generations.

It is that burden that political economist Amr Adly is worried about. He is not opposed to external borrowing, or to borrowing from the IMF. In fact, he said that an agreement with the IMF would serve to instil international confidence in the Egyptian economy in addition to being a source of financing. However, he said the agreement with the IMF would only help Egypt to manage the crisis, not to solve it.

Adly is worried about the ministry of finance’s plan for extensive borrowing. The government said it hoped to bring in around US$21 billion in external financing from the IMF, ancillary institutions, a Eurobond issue and assistance from other countries. An agreement with the IMF would help cut interest rates when Egypt goes to international markets for funding.

The agreement with the IMF would serve to improve macroeconomic indicators and rebuild the reserves in the hope that investment and tourism pick up, said Adly. However, he warned that this was a risk because there were other factors that could keep that from happening, such as the global slowdown, the recession in the EU, and the low international oil prices.

“The government is betting on relaunching the economy. If that does not happen, then we might be faced with a huge debt-servicing burden down the road that could cause us effectively to go bankrupt,” Adly said, recommending that borrowing should be kept to a minimum.

That does not look likely to happen, however. “All IMF-supported programmes have to be fully financed. In Egypt’s case, we would be looking for commitments of around US$5-6 billion from bilateral creditors before the programme is brought to the board, so that we can be sure that it is fully financed,” Jarvis told the Weekly in an email.

“The IMF will be working together with the Egyptian authorities in the coming weeks to secure this financing,” he added.

The bilateral donors could include the Gulf countries that have strongly supported Egypt since the ouster of former president Mohamed Morsi in the summer of 2013, with Egypt receiving over US$20 billion from Saudi Arabia, the United Arab Emirates and Kuwait since this date.

The money has come in various forms, including deposits with the CBE, grants, and the financing of fuel imports. But sceptics believe that Egypt may now have run its course with the Gulf funds, especially because of the current low oil prices. Saudi Arabia in April promised US$25 billion in investment, but none of this has yet come through, noted one observer who preferred to remain anonymous.

However, he said that if pressed and possibly in the context of an agreement with the IMF, the Saudis could provide financing that could be matched by Kuwait and the UAE.

Radwan agreed that the IMF agreement would play an important role. He noted that when Egypt was negotiating a previous loan back in 2011, finance ministers from the Gulf were waiting for the country to sign with the IMF before giving a helping hand. “Signing with the IMF reassures them,” he said.

Radwan said that the funds received from the Gulf in 2013-14 were a “political decision” because it was in the Gulf countries’ interest to support Egypt. “There is always a good intention on the part of the Gulf to support Egypt, but we need to manage our negotiations with them and prove we are serious about reform,” Radwan said.

Adly believes that the government lost an opportunity when it did not pursue serious structural reforms in 2013-14. The austerity measures that Egyptians were already feeling had been bound to be implemented with or without an IMF loan, Adly said. “We are paying the price for the deterioration of the economy over the past five years,” he added.

The government is already aiming to phase out electricity subsidies by 2019. It is also expected to continue the fuel subsidy cuts begun in July 2014 as part of its reform programme. President Abdel-Fattah al-Sisi has also spoken on several occasions recently of the need to better target the subsidies.

“It is about time we reformed the subsidies system, and now is the best time because of the global slump in oil prices,” Radwan noted.

Amidst such austerity measures, however, the government has continually reassured the public that it will be aiming to protect the most vulnerable groups in society. “Social protection is a cornerstone of the government’s reform programme,” noted Jarvis. It was an area where Egypt needed to capitalise on the Fund’s experience with other countries, Radwan added.            

One factor that is expected to make Egyptians’ lives harder is the devaluation of the pound that many observers see as waiting to happen. The shortage of hard currency revenues has put pressure on the value of the pound against the dollar, and it is now trading at around LE12 per dollar on the black market compared to an LE8.8 rate official rate.

 A further devaluation is foreseen as an outcome of the flexible exchange rate regime that will be adopted by the CBE as part of the agreement with the IMF.

 “The CBE’s monetary and exchange rate policy will aim to improve the functioning of the foreign exchange market, increase foreign reserves, and bring down inflation to single digits during the programme. Moving to a flexible exchange rate regime will strengthen competitiveness, support exports and tourism, and attract foreign direct investment,” an IMF statement said.

Capital Economics, a London-based economic research consultancy, has forecast that the pound will drop to LE9.5 per dollar by the end of 2016. Following the announcement of the agreement with the IMF, it said “the risk now is that it falls further.”

The value of the pound depends on various factors, including available hard currency resources, explained Radwan, adding that if tourism picked up this could make a huge difference to such resources.

Timing was also crucial, he said. “We are always late in decision-making, and this is costly,” he added, stressing the need for coordination between policy-makers to avoid contradictory statements that in themselves could be seen as negative signals.

Once the agreement is approved by the IMF executive board, it will need to be signed off by the Egyptian authorities, including the parliament.

Medhat al-Sherif, secretary of the parliament’s economic committee, acknowledged that “borrowing is a necessary evil at the moment,” saying that the government was reverting to the IMF for funds at a time when there were no other sources of hard currency.

He, too, is betting on a pickup in economic activity in the medium term and is hoping for more investment and more tourism. He is also counting on the Zohr Gas Field coming on line at the end of next year. The Italian oil company Eni announced the discovery in September 2015 of this giant gas field off the Egyptian coast.

He is also worried about the effect of the austerity measures on limited-income groups.

“It is important to agree on a timeline for these reforms to avoid knock-on effects,” he said, explaining that the value added tax (VAT) that is currently being reviewed by parliament should not be introduced to coincide with a devaluation of the pound because this could have grave repercussions on inflation and hence on consumers.

According to the IMF Website, the Extended Fund Facility helps countries address medium- and longer-term balance of payments problems reflecting distortions that require fundamental economic reforms.

Repayment is due four and a half to 10 years from the date of disbursement.

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