Egypt: Economic headwinds to persist despite IMF deal

29 Sep 2016

Egypt: Economic headwinds to persist despite IMF d...
  •   Despite the agreement of a three-year USD 12 bn loan signed with the International Monetary Fund (IMF) in August, high inflation and unemployment will continue to challenge Egypt’s economy well into 2017. 
  •   Investors will benefit from an easing of currency shortages and the eventual lifting of foreign exchange restrictions, but structural impediments to the private sector will remain in the form of corruption and the economic influence of the armed forces.  
  •   Reforms agreed as part of the IMF deal will increase the cost of living for Egyptian consumers, worsening discontent and increasing the potential for street protests and strikes.  

On 20 September, Deputy Finance Minister Ahmed Kouchouk told reporters in Cairo that Egypt was making progress in raising the funds necessary for the IMF to release the first tranche of the USD 12 bn loan, signed in August. The loan is part of a three-year, USD 21 bn economic programme intended to revive growth, with additional funding to be raised from the World Bank, bond markets, and others in coordination with the IMF. Assistance from the IMF is critical to helping Egypt ameliorate a range of economic challenges that have affected consumers and businesses alike. Shortages of foreign currency have made it difficult for local companies to source goods and materials and deterred investment by foreign businesses which have been unable to repatriate capital due to restrictions imposed by the central bank. On 14 September, Dutch airline KLM said that it would suspend flights to Cairo from January 2017 due to the effects of a devaluation of the Egyptian pound and currency restrictions. IMF aid is also critical to helping reduce the large budget deficit, at 12 percent of GDP, and to addressing high unemployment, which stands at 13 percent nationally and at 40 percent among Egyptian youth.

The IMF agreement, the largest loan by the lender in the region, had long been under discussion. Its completion signals a deeper commitment by the government to reforms than in the past, when changes were pledged but never implemented, as was the case with 2012 USD 4.8 bn IMF loan which was agreed but never finalised. Under the latest IMF programme, Egypt is obligated to enact new taxes, make further subsidy cuts, float the Egyptian pound, and increase the cost of some government services in exchange for financial assistance. Egypt has already made notable progress towards meeting its commitments, including the introduction of value added tax (VAT) in September and steep reductions in energy subsidies. Should Egyptian policymakers adhere to the IMF programme, this would have an overall positive impact on the business climate and for investors, notwithstanding the effects of changes such as an increase in the corporate income tax rate. For example, a devaluation of the local currency will boost the competitiveness of local industry and reduce the gap between the official and unofficial exchange rates, thus making the country more attractive for foreign investment.

IMF reforms may worsen social discontent

Despite the benefits to investors, the reforms laid out by the government will worsen the economic pressure on Egyptian consumers, thereby increasing the potential for civil unrest. Bloomberg reported on 19 September that inflation, currently approaching 16 percent, may rise to 20 percent due to the new VAT charges. The increase in taxes on goods and services follows the electricity ministry’s announcement in August that it would retroactively raise electricity prices for households by up to 40 percent in an attempt to phase out costly subsidies. Higher fuel and electricity prices have also hit key sectors of the local economy, especially energy-intensive industries like iron, steel, aluminium, copper, ceramic and glass, resulting in greater operating costs that businesses have warned will be passed on to consumers.

There is evidence of growing discontent and concern over government economic policies, conditions that may fuel higher levels of unrest in the future. Many Egyptians view austerity as something imposed by foreigners to benefit the wealthy at the expense of the poor. Reflecting this, in August a group of political parties, NGOs, and public figures wrote an open letter to President Abdel Fattah al-Sisi urging him to forgo the IMF loan, which they argued would increase the country’s debts and damage the most vulnerable segments of the population. Savings from reforms are supposed to be directed to tackling poverty; however, official commitments in this regard are viewed with scepticism by many Egyptians. The government has previously prioritised aid and scarce funds to support questionable projects such as the costly and unnecessary expansion of the Suez Canal, which has seen its revenues fall since the project was finished in August 2015.

Notwithstanding stringent government controls on dissent under Sisi, austerity measures and economic conditions have already fuelled sporadic unrest, including protests in Cairo over shortages in baby formula in September. There is also evidence of economic pressure in the labour force, with strikes and protests by factory workers motivated in part by grievances over wages that have failed to keep pace with rising prices. Further raising tensions, lawmakers agreed in principle to a plan that would raise annual fees for those who work abroad, a move that prompted heavy criticism from some of the expatriate associations that represent the 10 mn Egyptian nationals working outside the country. The intensity and frequency of unrest could worsen in response to economic policies and developments, including planned petrol subsidy cuts. Redundancies in the civil service or state-owned enterprises that are liberalised under the economic reforms could also prove a flashpoint, though Sisi has previously pledged not to cut staff as part of the civil service reforms.

Structural barriers to remain post-reforms

Under Sisi, Egypt has made some progress in restoring investor confidence and addressing some of the barriers to greater investment. According to the petroleum ministry, international oil companies plan to invest USD 35 bn in Egypt over the next five years, thanks in part to more flexible terms and perceptions of improved stability. This level of interest marks a sharp reversal from the disruption the sector faced after the 2011 revolution, and new investment in the energy sector, including in renewables and power plants, has helped to reduce the impact of chronic electricity shortages. However, despite the tangible gains in some areas, Egypt still ranks 131 out of 189 economies in the World Bank’s 2016 Doing Business report and 116 out of 140 economies in the World Economic Forum’s 2016 Competitiveness Report. Egypt’s poor ranking in both surveys reflects structural barriers to improved economic performance, some of which will remain even if the IMF deal is fully implemented.

Endemic corruption is among the key considerations that continue to undermine investment, despite successive government initiatives to tackle the problem. Bribery and facilitation payments are prevalent in the customs and other government services, and there is a precedent for serious penalties for foreign companies in their home jurisdictions for making illicit payments in Egypt. French industrial giant Alstom was fined USD 772 mn in November 2015 by US regulators for allegedly paying bribes in multiple markets, including up to USD 75 mn in Egypt. More recently, a major scandal relating to subsidies for the wheat sector has led to a corruption investigation into a former minister and highlighted widespread bribery and ineffective policy making.

Egypt has also given no indication that it will tackle the economic role of the military, which has become more entrenched under Sisi and extends into virtually all sectors, including foodstuffs, real estate, construction, transport, and services. The armed forces hold shares in a range of semi-public or private companies, most notably in infrastructure, and retired military officers benefit from a lucrative and well-developed network of cronyism. The extensive and opaque economic interests of the military, which may total 60 percent of GDP by some estimates, remain an impediment to greater investment and a larger role for the private sector. Foreign investors are at a competitive disadvantage to military-backed companies, which benefit from favouritism in the granting of contracts and permits, as well as access to cheaper labour in the form of conscripts.


Given the need for external financing, should Egypt fail to live up to its commitments to the IMF, the consequences for its economy would be serious. At present, evidence suggests that Cairo is likely to adhere to its obligations under the IMF deal, given reforms already implemented and a public commitment from Sisi himself. However, a change in the domestic political environment, possibly due to increased unrest or a backlash among key constituencies, could threaten the implementation of agreed reforms. Any loss of IMF support would damage Egypt’s credibility with other lenders, including Gulf states and bond markets, as well as potential investors that the country hopes to attract with reforms.

However, while Sisi has proven his willingness to take on politically sensitive issues such as subsidies, his government has not signalled a serious commitment to tackling corruption or to rolling back the economic influence of the military, a constituency on whom he relies for support. Thus, structural impediments to investment will persist even with the implementation of the IMF reforms, and only moderate improvements in the economic situation are likely over the three-year loan programme.  




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