The Egyptian economy has paid a high price after weeks of riots and political turmoil, writes Lamia Nabil.
The problems are clearly illustrated by the deterioration of aggregate indicators, a worsening budget deficit and decline in the cash reserve of foreign currency. There is also the matter of higher internal debt and stunted GDP growth.
Egypt’s sovereign credit rating has been cut to “junk” status (same as Greece) by Standard and Poor’s. Fitch similarly downgraded Egypt’s credit rating one notch to “B” from “B+”.
“Egypt’s downgrading reflects balance between short-term reserve pressure, political upheaval, a weak and deteriorating fiscal position and capital flight, against our assumption that an IMF program will be in place after the election,” Fitch said in its report on January 30.
Bonds sales and foreign deposits only bought Egypt little time. By mid-December, signs of worsening international reserves began to surface when banks started to bring dollars from their overseas accounts to meet growing local demand, followed, days later, by a government decree limiting foreign currency transfers in and out of Egypt to a maximum of $10,000 per traveler.
A clear indication that the era of defending the national currency was over, however, came when CBE revealed that Egypt’s foreign reserves had plunged to a “critical and minimum level,” announcing the introduction of a new foreign exchange auction mechanism on December 30 to buy and sell the US dollar. The Egyptian pound has weakened 8.2 percent versus the dollar to record low levels in the past year.
Whether this new policy of managing the country’s foreign exchange was an IMF loan-related condition or not remains unclear. But for now, it is the inflationary impact of the pound fall that is of immediate concern in a country that imports 60% of its food and 40% of its fuel, and where over 25% of the population – 50% in rural areas and city slums – live below the poverty line. Add to this an unemployment rate of 25% among young Egyptians, and the result is an explosive socioeconomic situation.
On the fiscal front, Egypt has been facing a growing deficit which reached 11% of GDP (about $28 billion) last year, and is expected by the end of the current 2012/13 fiscal, ending on June 30, to jump to 13% of GDP (close to $31 billion). With almost 80% of the state budget allocated to wages, subsidies and debt services, the country’s finance officials have little room for maneuvering. Looking back, raising taxes or cutting expenditure in the context of economic decline and rocky transition were not politically feasible and likely to carry a high social price. Borrowing, thus, seemed the only option left.
External official finances, however, were not readily available, and all seemed to be tied to Egypt undertaking necessary political and economic reforms to ensure stability and sustainability of the country and its economy. Borrowing from international markets was increasingly hard and costly. Post-Mubarak Egypt had twice approached the IMF, in May 2011 and again in January 2012, asking for a $3.2 billion loan, and in both cases, domestic politics hindered a fruitful conclusion of the talks.
Desperate for cash, Egypt turned to the IMF again in August 2012, this time asking for a $4.8 billion loan – a 50% increase from the previous request. Three months later, a preliminary agreement was reached between the parties based on Egypt’s commitment to implement a homegrown economic reform program which aims to reduce the country’s budget deficit from 11% of GDP this year to 8.5% of GDP by 2014. This, according to the plan, is to be achieved, inter alia, through a mélange of tax hikes on sales, income and property, and through expenditure cuts.
But the loan arrangement is now on hold after Egypt retreated last December from raising sales taxes that were part of the IMF deal, hours after they were announced.
“The direct impact of riots and demonstrators is on the country’s security; Egypt is suffering from a debilitating lack of power for governance and a lack of boldness in decision making. All these reasons affect the attractiveness of the Egyptian economy for foreign investment,” Mohammed Saeed, Managing Director of IDT Consulting and Information Systems Company, said.
The current government agrees on IMF’s conditions, but it is not able to meet these requirements, despite the importance of restructuring the Egyptian economy.
Saeed added that tourism is one of the productive units which stopped due to the deterioration of the economic situation with the macroeconomic indicators. Tourism revenues are one of the main resources of foreign cash in Egypt, almost 13 percent of GDP. The remittances from Egyptians working abroad is another source of foreign currency that helped in the current pound crisis.
Saeed said that the Egyptian Stock Exchange still experiences trading at lower prices than its value, with less expectations of positive outlook in the short term especially with the lack of liquidity and foreign investment.
Dr. Ehab El-Desoky, Director of Center for Research and Consultancy at Sadat Academy expected the Egyptian pound to drop against the dollar.
He added that the effect of the political clashes on macroeconomic indicators depends on the ongoing riots and demonstrators; despite that foreign investors were willing to support the Egyptian economy, the largest ratio in making such a decision depends on the potential profits and the extent of confidence in the future of the economy. Riots and demonstrators may delay the foreign investors’ decisions to invest in Egypt.
And this is where Egypt’s ultimate economic policy challenge lies this year: how to reconcile the high expectations of ordinary Egyptians for a better living, and respond to their passionate cry made two years ago at Cairo’s Tahrir Square for “bread, freedom and social justice,” while, at the same time, implementing progress in an increasingly chaotic political setting.