Friday,24 March, 2017
Current issue | Issue 1325, (22 December 2016 - 4 January 2017)
Friday,24 March, 2017
Issue 1325, (22 December 2016 - 4 January 2017)

Ahram Weekly

The year reform broke loose

The government has got through more economic reforms over the past six months than over three decades

The year reform broke loose
The year reform broke loose

For years, the government has been hearing advice that it needs to reform its finances, tighten the country’s budget deficit and allow for exchange-rate flexibility. Implementing the new value-added tax (VAT) and phasing out energy subsidies were some of the measures it had repeatedly said it would carry out, but for some reason it never got down to them.

This year it went all out with these reforms and more, and it did so almost all at once.

Reforms by the dozen: In the summer, the government introduced a new civil service law aimed at improving the performance of the state bureaucracy, trimming the number of civil servants, and cutting the public-sector wage bill. The law was met with much opposition when it was first proposed in 2015.

In September, the new VAT went into effect after eight years of discussion. The implementation of the VAT and the civil service law was a precondition for the World Bank’s approval of a $3 billion loan to Egypt over three years.

Early November brought the decision to float the Egyptian pound immediately followed by a slashing of the subsidies on fuel. Some items were subject to over 80 per cent increase in prices after the subsidy cuts.

These decisions had been expected as the International Monetary Fund (IMF), from which Egypt was seeking $12 billion in financing, would not approve the financing facility if these two measures were not implemented. The IMF said that these measures were milestones that the government had set for itself in the plan it had presented to parliament in March.

The X factor: But when have such commitments stopped the government from bailing out before? The “X factor” this year was the difficult situation the economy was in and the need for hard-currency financing. The budget deficit in fiscal year 2015-16 came to 12.2 per cent, with total government debt of around 98 per cent of GDP.

Traditional hard-currency earners such as tourism, the Suez Canal, exports and remittances were not faring too well. Tourism revenues were down around 50 per cent in fiscal year 2015-16, coming to $3.8 billion compared to $7.4 billion the year before.

Tourism has been slow at recovering from the security concerns which followed the crash of a Russian plane over Sharm El-Sheikh in October 2015. And despite heightened safety measures taken by the government, British and Russian airlines have not resumed their flights to the tourist resort that is responsible for about 30 per cent of Egypt’s tourists, with most visitors being citizens of the UK and Russia.

Suez Canal revenues came to around $5 billion, their average for the past six years. Remittances came to around 17 billion compared to $19 billion the year before. And exports shrunk to around $19 billion compared to $22 billion the year before largely because of the effect of depressed oil prices on Egypt’s oil exports.

Furthermore, there was a balance of payments deficit of $2.8 billion compared to a surplus of $3.7 billion the year before. The country’s international reserves, meanwhile, were running low, reaching just three months’ worth of imports in June. In the meantime, there was no external support unlike in previous years, especially 2013-14 when Egypt received over $11 billion in cash and in-kind support from the Gulf.

Pressure on the pound was strong despite a 13 per cent devaluation in March. Prior to the floatation announcement in November, the pound had lost 100 per cent of its value on the black market, and dollar shortages were straining economic activity.

Unfathomable prices: The problem with the reforms is that they have hit people hard. Before they could take in the application of the new VAT and the subsequent rise in prices, people were dealt a new blow by the floatation of the pound and the devastating effect this would have on prices.

The fuel subsidy cuts meant a surge in transportation costs for individuals as well as in the cost of goods. The cost of keeping machinery such as tractors and factories running also became expensive, thus increasing the price of manufactured products.

Meanwhile, the depreciation in the value of the pound by 100 per cent resulted in price increases of 50 to 100 per cent due to the often-high imported components of locally produced goods.

Inflation already hit around 20 per cent in November and is expected to exceed that figure on the back of these reforms. Though many traders were factoring in the black-market dollar rate to their prices prior to the floatation, many basic food items had been imported at the cheaper official price. London-based research house Capital Economics has estimated that every 10 per cent fall in the currency against the US dollar pushes up the overall headline rate by 1.5-2.0 per cent.

Inflation had been on the rise since January, ending up at around 14 per cent in September. “The government is confusing getting rid of poverty with getting rid of the poor” was a common joke circulating on Facebook, indicating the extent to which people’s incomes have lost their purchasing power, with the poor and middle classes bearing the brunt of the problem.

Who is to blame?: While previous government reforms were often seen as doing “too little, too late,” this year’s reforms, though certainly not too little, have also been seen as too late. Observers believe that if these reforms had been made even a year earlier, they would not have hit people so hard, as the delay has meant that the reforms could not be phased in and a good part of the depreciation of the pound was tied to loss of confidence in the economy.

The measures were long overdue, Mahmoud Mohieldin, World Bank Group senior vice-president for 2030 Development, told popular Egyptian TV talk show Hona Al-Assema prior to the announcement of the reforms. The shocks to the economy should have been dealt with in their own time without wasting hard currency reserves, he said. “If this had happened, Egypt would not have found itself in this situation.”

Former deputy prime minister Ziad Bahaaeddin also recently wrote that it was not the recent measures that had led to the impoverishment of Egyptians, but rather the “economic policies adopted during the last two years that have exacerbated the crisis and inevitably led to these measures.”

These included the mismanagement of investment in the months following the Sharm El-Sheikh Economic Development Conference in 2014, a focus on “unjustifiably costly mega-projects,” and state competition with the private sector in areas that require no state intervention, Bahaaeddin said.

Others say the government left things to deteriorate so it could bring in the reforms without being overly questioned about them.

“The absence of an economic strategy, usually put down to incompetence or neglect, can be viewed in this framework as a deliberate attempt to force the Egyptian people to accept their abandonment by the state without calling its legitimacy into question,” said a study by the Egyptian Centre for Economic and Social Rights (ECESR), an NGO, entitled “From the 1990s to Now: The IMF Loan Exacerbating the Crisis”.

First things first: One of the main criticisms of the government is that it should have done more to protect the poor before initiating its economic reforms.

A study by the ECESR entitled “Black Thursday’s Policies: Liberalisation without Protection” accuses the government of dragging its feet over developing an effective safety net, funding social security programmes and restructuring pension schemes. The study claims the reforms could increase poverty rates to unprecedented levels. According to the Central Agency for Public Mobilisation and Statistics (CAPMAS), the state statistics body, 27 per cent of the population is currently living in poverty.

Following the announcement of the reforms, the government increased the amounts allocated to individuals holding ration cards from LE18 to LE21 and expanded the Karama and Takaful cash transfer programmes to 1.7 million families by the end of the current fiscal year. Both these programmes support the elderly, the handicapped and families with children living in poverty.

The government is also making some basic commodities available at cheaper prices through government and army-owned outlets. Moreover, the delivery price of some crops has been increased in support of local farmers and to encourage them to keep cultivating crops such as wheat, sugar and corn.

But these measures seem like a drop in the ocean given the way prices have jumped, even for ration-card holders. The price of sugar for ration-card holders went up from LE5 to LE7 per kilogram, for example. Rice increased from LE4.5 to LE5.25 per kilogram.

“Floatation was the easiest decision,” businessman Samih Sawiris, chairman of Orascom Development Holdings, recently said. In his opinion, the much-needed reforms should have come first to attract investment and get the economy moving. That would have enabled the immediate benefit of the reforms to be felt, unlike the case now when people are suffering from the hikes in prices without seeing the benefits.

Sawiris, who made his remarks at a recent conference organised by the American Chamber of Commerce in Cairo (AmCham), said that other needed reforms were moving at a much slower pace.

To get the economy moving, more structural reforms, cutting of red tape and facilitating investment have been called for. A Supreme Investment Council has been created, which has passed a handful of investment friendly regulations which include granting tax exemptions and cuts on industrial and agricultural investments for import replacements as well as export purposes in certain locations, including Upper Egypt.

A new investment law that overcomes the shortcomings of former investment laws is scheduled to be ready before the end of the year. The stock market has also felt the immediate benefit of the floatation, with Egyptian stocks now at bargain prices.

But if the government is to attract investment, it will need to show better management of the crisis. The availability of pharmaceuticals has been one area of concern. Since the floatation, many pharmaceuticals have disappeared from local markets because the government is not allowing a hike in prices to accommodate the new value of the pound.

This has meant that the prices of many products are now less than the cost of manufacturing or importing them. Accordingly, pharmaceutical companies have refrained from making new imports, and stocks have been running out and have not been being replenished. The same applies to locally produced medicines that use imported active substances.

This situation has repeated itself in the fertilisers industry, where again the government’s refusal to allow for prices to accommodate the depreciation of the pound has caused a shortage of supply.

The government needs to think through decisions thoroughly before issuing them. On more than one occasion this year it has taken a decision, only to go back on it afterwards. The first instance was with wheat import specifications, when it changed its mind several times about allowing traces of ergot, a fungus affecting cereals, in wheat imports into Egypt.

More recently, it issued a decision eliminating customs duties on imported chickens, only to repeal it a few days later after criticisms that it would harm the local industry.

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