Egypt Hopes the Benefits of Economic Reform Outweigh the Risks

8 MINS READOct 28, 2016 | 10:12 GMT
Egyptians buy sugar from a truck in Cairo. The government is struggling to keep stores stocked with subsidized goods.
Egyptians buy sugar from a truck in Cairo. The government is struggling to keep stores stocked with subsidized goods.
Forecast Bullets
  • Economic reforms will stir up opposition across the socio-economic spectrum, but it will not become a credible threat to the government. 
  • Egypt will continue depending on foreign aid despite its desire for a more independent foreign policy.
  • Security threats will magnify the need for economic stability and social assistance and will undermine trust in the government.

The details of Egypt's ambitious economic reform measures are not settled, but the plan is already mired in controversy. The International Monetary Fund has deemed Egypt's financial position untenable and has made a new loan package contingent on change. Among other things, this means Cairo must implement further painful reforms to fuel subsidies, as well as tax increases and spending cuts — none of which are popular with entrenched interest groups or with a population beleaguered by high poverty rates. But even though popular pressure is mounting, the government cannot afford to turn back — either literally and figuratively — lest it risk reversing the progress made so far. Pushback from the disaffected public will continue, but it will not spawn a massive protest movement like those that brought down President Hosni Mubarak or the Muslim Brotherhood. Even if President Abdel Fattah al-Sisi has lost the shine he had when he took office in 2014, Egyptians still see his government, backed by the Supreme Council of the Armed Forces, as their best option. So the reforms will go forward, however unpopular and inefficient they may be.

Securing Aid

Cairo is pursuing the largest aid package that the IMF has ever awarded to a nation in the Middle East — $12 billion disbursed over three years, so long as the IMF's contributions are matched by loans from other global creditors and are supported by reform. The reform measures necessary to secure the loan have been partly in place for some time — even before the request was officially announced in August. In April, the government approved a plan to reduce the public deficit in 2016-17 to 10 percent of gross domestic product; it has consistently hovered at 11-13 percent. And much of what was agreed to in April, such as further fuel subsidy reform, had already been in the works since al-Sisi came to power in 2014. Cairo hopes that the IMF reviews Egypt's efforts so far and finalizes the package in the next two months, a decision that would make 2017 a year of reform.

Although al-Sisi pursued reforms early in his term, his initial efforts were carried out amid a groundswell of post-election fervor and relief at the ouster of President Mohammed Morsi. That effect has waned in the past two years. And while al-Sisi's latest measures are intended to spur growth and free Egypt from dependence on external assistance in the long run, the reforms are mostly a band-aid on the deficit and a tool to secure IMF aid. Furthermore, they will be painful for the public. Like any government looking to rein in a bloated budget amid falling revenue, Egypt is seeking to increase revenue while reducing government expenditures. If not executed well, this could squeeze the population, which is already burdened by a high poverty rate, piling on taxes and reducing subsidies. And the push to devalue the Egyptian pound will almost certainly lead to a decline in purchasing power across the economic spectrum, undermining the long-term drive to increase domestic consumption. The Egyptian government will provide piecemeal solutions to make this bitter medicine more palatable, especially for vulnerable and vocal groups. And though a massive protest movement is unlikely to emerge, these measures will hurt investor and consumer confidence in the short term.

Lowering Spending, Raising Taxes

Within three years, Cairo plans to entirely phase out domestic fuel subsidies. This ambitious goal would complete the reform effort that began in 2014 and would be followed in 2019 by the end of electricity subsidies. The focus on fuel is motivated by the government's recognition that the expensive subsidies have helped wealthier people who own their own vehicle more than the poor. So far, the cuts have worked to limit government expenditures: Petroleum subsidy costs dropped from 71.5 billion Egyptian pounds ($8.05 billion) in 2014-15 to 55 billion Egyptian pounds this past fiscal year. (The drop in global oil prices was a factor as well.) In the 2016-17 fiscal year, these costs are budgeted to decline further, to 35 billion Egyptian pounds.

The precipitous decline in subsidies has spooked some oil and natural gas companies from seeking long-term payment programs. But fully phasing them out will be tricky, and consumers are already voicing dissent. Similarly, there has been pushback against new electricity and water prices imposed in recent months, which could slow the implementation of a complete phaseout by 2019.

In contrast to its zeal to reduce fuel subsidies, Cairo has been much more cautious with food-related subsidy payments because of modern Egypt's long history of food riots. But with spending out of control, the Ministry of Finance has been trying novel means of distributing assistance, namely the use of smart cards to help poorer consumers pay for essential goods. This is already causing controversy, however, particularly over precisely who is eligible for assistance. The new method for disbursing cash payments directly loaded onto the cards will not stop unrest, particularly from upper- and middle-class Egyptians who do not qualify for help but who will see their purchasing power erode.

The cost of living in Egypt has gone up slightly in recent years. Erratic policies under Mohammed Morsi's government in 2012 led to further price uncertainty.

Cairo will also find it difficult to keep stores stocked with subsidized goods. The government is already struggling to distribute proper amounts of subsidized food staples, particularly sugar, cooking oil and rice, and it resorted to confiscating food stores from private companies and traders in October without compensation to make up for shortfalls at its subsidized outlets. Though this has less to do with actual food shortages than it does with inefficiencies in Egypt's supply chain, the inability to access staples is fostering doubt about the promise of economic reform. The promises that subsidy reform will lead to enhanced consumer flexibility, empowerment and wider availability of staples, laid out at the March 2015 Sharm el-Sheikh Egyptian investment conference, are particularly in question. Even the president's straightforward promise in April not to raise food prices has proved untrue. The price of subsidized sugar has risen from 6 Egyptian pounds to 7 Egyptian pounds, and the cost of unsubsidized products has risen even more.

The Egyptian government is trying to cut subsidies to free up funds for investment and payments on domestic and foreign debt. But reducing subsidies without causing social unrest is difficult to do.

To complement spending reductions — and maintain some spending on food subsidies — the government is planning to raise taxes and cut administrative costs. This is included in next year's budget and in the overall vision for the period ending in 2019. A complete overhaul of the Egyptian tax code is in the works, designed to increase Egypt's tax intake from 13 percent of GDP to 18 percent. The government is also slashing public sector budgetary allotment for ministries in an effort to reduce the bill for government administration without touching sensitive public sector wages.

Most expected government revenue comes from taxes. It is still unclear whether Egypt will be able to meet its revenue target for the current budgetary cycle.

But implementing this tax scheme will not be easy. For one, Cairo tends to fall short of its desired tax revenue, putting the effectiveness of such plans in question. For example, by the final month of last fiscal year, Egypt had yet to take in more than a quarter of its budgeted tax revenue. Upper- and middle-class constituents have also actively pushed back against the policy. Lawyers and accountants have mobilized, asking for an exemption from the new 13 percent value-added tax, set to increase to 14 percent next year. Some have even appealed the passage of the law and are due in court in November. Poorer classes will bear the brunt of the increase in excise taxes on basic goods, including food staples, even though such goods will be exempt from the new value-added tax. This is a factor in efforts to organize popular protests against economic reforms, including a protest planned for Nov. 11.

Dismal Prospects

Public unrest and resulting economic uncertainty are ironically the result of reform measures designed to help Egypt's near-term economic stability. The result is an environment that is currently not conducive to investment. Cairo's seizure of rice and sugar stores from private companies for the subsidized market, for example, does little for investor confidence. Furthermore, that the government is setting price caps on commodities and dictating private sector prices for products has ruffled feathers in recent weeks. Cairo insists the measures are temporary for Egypt's extraordinary circumstances, but business owners are not convinced.

Egypt will be vulnerable as long as its economic stagnation forces it to nurture relationships with Western powers and with Gulf Cooperation Council nations. Amid regional instability, Cairo would prefer latitude in foreign policy decision-making, specifically with respect to Gulf cash infusions that come with foreign policy strings attached and U.S. help that comes with lectures on human rights. But this situation will not change in the near future. Egypt will continue to court allies for loans and grants to bolster its position. And considering Egypt's concerning security picture, there are more reasons than ever to try to convince constituents to weather the pain of economic reform. In this, Cairo hopes to dissuade recruitment into militant organizations as well as to deny anti-government organizations further fodder. With the government in Cairo more focused than ever on silencing opposition, whether secular or Islamist, Egyptians have become disillusioned with mass protest. And it is this hesitation that the government is counting on to buy time for its economic reforms to take effect.

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