Egypt’s economy will face tougher hurdles in 2013

Talk of economic recovery has all but gone silent in Egypt, replaced by doomsday predictions about the depths to which the country’s dire conditions will spiral.

While the foundations for a robust economy still exist, gross mismanagement continues to add stress to the country’s ailing finances and widening budget deficit. Much like in 2011, the economic turbulence of 2012 mirrored lapses in Egypt’s political transition, and the scenario is likely to carry on well into the coming year.

When asked about the main factor hindering recovery this past year, and which will continue to plague the economy moving forward, five experts cited shortcomings in top-level policy formulation, decision-making and the frailty of the political structure.

Answers ranged from the “volatile domestic political environment” to lack of leadership and vision, the “absence of the state” and, of course, the current state of polarization which is unlikely to be letting up anytime soon.

Angus Blair, founder of The Signet Institute, a Cairo-based think-tank on MENA economies, says, “I do not expect the political ‘noise’ to dampen any time soon given the clear polarization in society, politically, and the slower economy has created further economic problems.”

“The government’s economic plan is going to have to be more creative and brave to build domestic confidence and economic growth,” he adds.

Uncertainty loomed over the market and dented investor confidence in the months following the 25 January uprising, and was further dampened under the rule of the military council and the prolonged transition process. The light at the end of the tunnel — or so it seemed — was the promise of a free and fair election culminating with a democratically elected president who would steer the economy back on track.

What has happened instead is that this uncertainty has gone from hovering threateningly above the economic stratosphere to taking root, and in turn, has struck the core of the state’s finances.

Wael Ziada, head of research at regional investment bank EFG-Hermes, says the key in the coming year will be “reducing the budget deficit and trying to prevent a case of a sharp and disorderly devaluation [of the pound],” adding that the government must move quickly to meet rising local demand for energy and restructure subsidies.

Egypt’s budget deficit increased to LE80.7 billion (US$13 billion) during the first five months of the current fiscal year 2012/13, increasing by an additional 37 percent since President Mohamed Morsy took office.

As a result of “poor and misguided measures and actions,” says Karim Helal, investment banking adviser and chairman of the Asean-Egypt Business Association, the coming year will see Egypt dealing with a “monstrous budget and fiscal deficit, dwindling reserves, inflationary pressure, pressure on the pound and its implications, deteriorating credit rating, inevitable and long overdue hard to swallow pills in terms of economic reforms, and near zero foreign direct investment.”

Foreign reserves have dwindled by more than half since January 2011, reaching US$15.035 billion, highly compromising the state’s ability to import vital food and petroleum products. In the past two years, the central bank has burned through around US$20 billion to prop up the Egyptian pound, which has lost more than 5 percent of its value, recently hitting an eight-year low and last trading at 6.17 to the US dollar.

While facing criticism by some for not letting the pound fall to its real rate and maintaining instead the level of foreign reserves, the central bank’s policy has been lauded by others for saving the pound from a dramatic and sudden devaluation.

It’s fair to argue that the strategy was initially a short-term measure, without realizing how long the state of political paralysis would continue to affect the economy. In 2012, the government then resorted to relying on funds from Qatar to replenish foreign reserves. An expert recently said further support is anticipated from Turkey as well as the African Development Bank. That is yet another highly unsustainable short-term strategy, further increasing Egypt’s debts.

While less volatile, the more gradual devaluation will still result in higher inflation and rising food prices amid the enduring economic slowdown creating few jobs and leading to rising unemployment.

The exponentially deepening funding crisis is made worse by Standard & Poor’s recent cut of Egypt’s long-term sovereign rating to ‘B-’ from ‘B’, making it more costly to borrow.

“The negative outlook reflects our view that a further downgrade is possible if a significant worsening of the domestic political situation results in a sharp deterioration of economic indicators,” S&P said.

Further compounding the situation is the decision to postpone the final approval on the US$4.8 billion International Monetary Fund loan.

While contentious in and of itself among rights groups and activists, many economists say at this point, there are few other options.

In a recent note on Egypt, Capital Economics says, “Without an IMF deal (or financing assistance from the Gulf), Egypt could be tipped into a full-blown balance of payments crisis. This would see the pound collapse, bond yields surge and output slump.”

Much of the financing promised to Egypt is contingent on the IMF loan, which was set for 19 December, but delayed in the midst of political turbulence in the aftermath of Morsy’s November constitutional declaration.

The IMF has called on Egypt to curb energy subsidies, make modifications to taxes and has advised that it allow “the currency to move in line with market forces — while avoiding excessive short-term volatility.”

But a batch of new taxes introduced inconspicuously during the period in which Morsy’s decisions were immune from judicial review, were swiftly suspended when they faced a harsh backlash the moment they were publicized.

The taxes will be implemented however, and the suspension was a temporary political maneuver.

Still, the move highlighted the inability of the president and the government to remain steadfast in their decisions. Whether or not these decisions and retractions are prudent is an afterthought; what’s become apparent is the lack of broad support for the president as well as the government’s inability to put together a solid economic program.

It was months before the Cabinet could come up with a clear economic program for Egypt. When it was finally made public in November after being presented to the IMF delegation, the program was criticized for bearing a stark resemblance to the one of Hosni Mubarak’s “reform” Cabinet.

On a more optimistic note, Alaa Ezz, secretary general of Egypt’s Federation of Industries, says political unrest may ease after parliamentary elections in the first quarter of the year, adding that “subject to the conclusion of the IMF agreement, and a highly necessary dialogue and consensus on major issues, it is expected that our [credit] rating will improve and investments will start flowing back, as well as tourism.”

But the proper environment that would bring back tourism and foreign direct investment brings us back to the issue at hand: the failure of the state to guarantee security and make decisions that would build investor confidence.

After recovering slightly in 2012, tourism numbers began falling again in November when violent protests pitted supporters and opponents of Morsy against one other.

Christmas is typically a high season for tourists, but this year cancellations abound. This in addition to findings of a recent study released by the Tourism Ministry showing that the sector has been losing US$267 million a week since the onset of the 25 January uprising, leading to layoffs and revenue losses.

Cairo tourism had not been able to rebound throughout the transition, but in 2012, even areas that had been considered calmer and far from any direct action were hit first by a wave of kidnappings in Sinai then by a string of attacks on security premises in Arish.

If and until the president and government can sustain security in the area, there’s little reason for tourists to return — the sector cannot stand to be ignored much longer, and like Egypt’s economy, must be protected from bouts of political instability.

Capital Economics describes the situation eloquently: “Egypt’s post-revolution transition continues to be bumpy…and for every two steps forward the country seems to take one back. This looks set to continue for much of the next year.”

Going forward, what Blair recommends is for Egypt to cut corporate tax by 2 percent and create incentives that would bring small and medium enterprises into the formal sector, among other measures.

All agreed that Egypt’s economic conditions need to be communicated openly and honestly with citizens in order to reach a level of consensus on the measures that need to be taken.

Moreover, Blair says the state needs to “fundamentally tackle hydrocarbon subsidies [and] start an agricultural revolution, also using investment incentives, to encourage industrial farming, hydroponics, and efficient water use.”

As well as investing in mass public transport and better roads, “the government still has enormous work to do to cut bureaucracy,” he adds.

Helal agrees, and adds that “infrastructure and mega projects are a priority, requiring massive investments which will trickle down fast…and create employment on a much needed large scale.”

Ezz, similarly, says the economic question needs to be thrust to the forefront. “The budget deficit has to be tackled through tax reforms (direct and indirect),” and the state’s expenses must be rationalized, with subsidies as a priority.

“In all conditions, international commitments must be respected, otherwise, we are moving back by decades.”

This piece was originally published in Egypt Independent's weekly print edition.

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