A currency that has depreciated more than had been expected, scheduled energy subsidy cuts, and key decisions to be taken by the government over the next six months are some of the things Egyptians found out about when the International Monetary Fund (IMF) released documents relating to its agreement with the Egyptian government this week.
The IMF approved an Extended Fund Facility (EFF) with the government in November 2016. Based on the agreement, financing of up to $12 billion is to be made available to the government over a three-year period. Semi-annual reviews will be carried out regularly before disbursement.
Egypt received the first tranche of $2.75 in November 2016. A second tranche of $1.25 billion is expected this spring. According to Chris Jarvis, IMF mission chief for Egypt, speaking during an online press conference, a mission will visit Egypt towards the end of February to assess the situation and report back to the IMF’s executive board. All being well, the second tranche will be released in late April, he said.
The benchmarks that will be looked at by the mission, according to Jarvis, include the money supply, credit from the Central Bank of Egypt (CBE), and the size of the government deficit, together with the level of the international reserves. Jarvis said that final information was not available, but early indications showed that the benchmarks were likely to be met.
The mission will make sure that policies are on track, he said.
According to the IMF, other benchmarks in the programme include the primary fiscal balance, fuel subsidies, and the accumulation of external debt payment arrears, tax revenues, and Egyptian General Petroleum Corporation arrears.
Jarvis said Egypt’s reform programme had got off to a good start and that the government was doing what it had said it would do. He acknowledged that the “currency depreciated more than we expected, but it seems to have stabilised at a new level and there is potential for an appreciation as the situation sorts itself out.”
He added that this was often the case when countries liberalised their exchange rate regimes. “Exchange rate liberalisations are always difficult,” Jarvis said.
The reports that have been released include the Memorandum of Economic and Financial Policies, which is the government’s statement, and the CBE’s statement of its economic policies throughout the duration of the programme. It also includes a staff report which explains the IMF’s report to its board and to the public.
Not only have estimates been off about the exchange rate, but inflation has also not behaved as expected either. The IMF had predicted inflation in Egypt would increase to around 19 per cent in 2016/17. Inflation came to around 24 per cent in December 2016.
Nonetheless, the IMF remains optimistic, expecting inflation to come down in the second quarter of 2017. “By the second half, we would expect to see significant falls in inflation,” Jarvis said. Inflation is projected to decline to around seven per cent over the medium term, the IMF said.
Inflation increased on the back of fuel price increases, the introduction of the value added tax (VAT), and the depreciation of the exchange rate.
On the bright side, some of the risks set out by the IMF staff report ahead of the agreement did not materialise, said Jarvis. The IMF was worried that adjustment in the foreign exchange market might be volatile and disruptive, and that has not happened, Jarvis said.
Another risk was that the government would not follow through with the reforms, and that had not happened either, he added.
“The political commitment is important, because sticking to the policies that the government decided to adopt is what will bring inflation down,” Jarvis said. Containing the budget deficit and limiting increases in the money supply are particularly important if inflation is to be contained, he said.
The Egyptian pound is now trading at around LE18.5 to the dollar, compared to LE8.88 which was the official rate prior to the floatation. Prior estimates for the fair value of the dollar against the pound were set between LE12-13.
“It is more depreciated than expected, given the fundamentals. It may be that we were wrong about the fundamentals, but what is more likely is that there has been an overshooting, which happens in the initial period when the exchange rate is more depreciated than it will turn out to be,” Jarvis said.
“The important thing is that it is a genuine equilibrium exchange rate, as many people want to sell as well as buy foreign exchange,” Jarvis said. That “is a tremendous improvement in increasing the availability of the exchange rate in Egypt”.
He praised the CBE for getting “out of the business of supplying foreign exchange”, which has been helpful because it allows for a true market to form and prevents foreign exchange rates from being heavily influenced by what the CBE might do.
Jarvis also praised the commercial banks for stepping up and helping to create a well-functioning foreign exchange market.
The CBE has also promised to lift remaining restrictions on foreign currency transactions. “The current limit of $100,000 on transfers abroad by individuals without an underlying commercial transaction and a cap of $50,000 on cash deposits for importing non-priority goods will also be lifted by June 30, 2017,” the report said.
The IMF report also showed that by the end of the programme, Egypt’s gross international reserves are expected to reach around $33 billion. Net international reserves reached around $24 billion in December 2016.
The IMF documents also confirm the government’s plan to phase out fuel and energy subsidies. The Egyptian “authorities are prepared to further adjust fuel prices or take other measures as needed to offset any additional costs in the event of larger than projected depreciation of the pound or higher global oil prices,” the IMF staff report said.
According to the report, the government has committed to achieving a100 per cent pre-tax cost recovery ratio in 2018-19 and to eliminating electricity subsidies by 2020-21. Following the November increases in petrol and diesel prices, the government has achieved a pre-tax cost recovery ratio of 56 per cent.
The subsidy cuts are part of a plan to contain the budget deficit and public debt. The budget deficit stood at around 12 per cent of GDP in 2015-16, and general government debt at 95 per cent of GDP. The overall deficit is expected to fall during the programme to 4.7 per cent. A government debt of 85.8 per cent of GDP in three years and 78.3 per cent of GDP by 2020/21 is targeted.
Containing increases in public-sector salary costs is another part of achieving that, and there were large increases, especially in the second half of 2013. These were one of the contributing factors to the high public deficit, Jarvis said.
“It is important that wages are kept restrained if inflation is to be contained,” he said, explaining that higher wages would translate into higher deficits if in the public sector and higher prices if in the private sector, both of which feed inflation.
Egyptians have been hard hit by the inflation which has accompanied the reforms taken by the government. “If they could not predict the extent to which the pound would depreciate then they did not know what they were doing,” said Ahmed Salah, a government employee in Aswan.
He was not reassured by government announcements that it was looking out for the most vulnerable.
The IMF report praised the government’s intention to increase social spending to one per cent of GDP. This includes spending on food subsidies, support programmes for women, the elderly and children, such as the takaful and karama programmes, and school meals.
The programme also intends to make it easier for women to go into the work force by improving public-sector nurseries and the safety of public transportation.
“Many people, me included, do not fit under any of these categories. What will happen to us,” Salah questioned.
“The adjustment of a budget deficit, bringing a high budget deficit down, is always difficult, and there are always some people that lose in that process. But it has to be done; otherwise, people lose a lot more,” said Jarvis at the press conference.
One of the surprises of the documents was scheduled capital gains or a stamp tax on stock exchange transactions. The IMF documents reveal that the government has promised to reinstate either of the two in May 2017.
The capital gains tax has been suspended since 2015. It is not clear how this will be re-implemented, given that the Higher Investment Council last year extended the suspension for three more years.
The Ministry of Finance meanwhile has said in a press release that it is bound by the Higher Investment Council’s decision to suspend the implementation of the tax. It said the IMF report had been prepared in the light of the existing law which states that the delay expires in May 2017 and prior to the issuance of the decision.
The ministry statement said that work was underway to amend the law and include a three-year postponement along with other amendments within the new investment law. The EGX30 index lost 3.74 per cent on Thursday following the reports.
Egypt’s financing for the next three years exceeds $30 billion. To approve the loan, the IMF required Egypt to provide an additional $6 billion from other sources. Egypt has yet to secure additional financing for the next two years.
“The financing gaps for 2017/18 and 2018/19 are much smaller, and there are good prospects that they can be covered with multilateral support, rollovers of some maturing liabilities, and little fresh financing,” the IMF said.
GDP growth is expected to remain stable at about four per cent this fiscal year, weighed down by the effect of the reform measures on economic activity. However, growth is forecast to increase to five to six per cent in the medium term.