Egypt should be prepared to raise interest rates if inflation does not abate and should work to cut its budget deficit, the International Monetary Fund (IMF) said in a report.
Core urban inflation, the country’s most closely watched price indicator, still remains high at 13.6 percent after having soared to above 23 percent in August 2008.
"Persistently high headline inflation risks generating inflationary momentum through its effect on expectations," the Washington-based body said.
The IMF said recent rate holds were appropriate and that inflationary pressures driven by higher fruit and vegetable prices were "likely to be mostly idiosyncratic and not demand induced."
Egypt’s central bank has held rates steady since September after cutting them six times earlier in 2009.
The IMF also said Egypt, which is targeting a deficit of 8.4 percent of gross domestic product (GDP) this fiscal year, should seek to shave 1.5 to 2 percentage points off of that next year to signal to investors its reforms are on track.
That would "encourage a more rapid private sector response to boost FDI and growth," the IMF said.
Prime Minister Ahmed Nazif said on Wednesday he expected tax revenue to decline in the fiscal year that starts this July, complicating efforts to cut the deficit.
Egypt was protected from the worst of the global financial crisis due to reforms introduced by Nazif’s government since 2004, the IMF said.
The IMF conceded that major reforms may be difficult to adopt as elections approach but that the state should continue to strengthen tax compliance and cut down on subsidy abuse while resisting pressure to spend more.
Egypt has approved 34 billion Egyptian pounds in infrastructure spending to stimulate the economy since the crisis hit. It spent $19 billion in 2008/09 on its subsidy programme, more than one-third of government spending.
A government plan to implement new property taxes has stalled after widespread opposition. Egypt will hold elections for parliament later this year and for the president next year.
Officials say Egypt has simplified procedures and will enact a new law this year to encourage further private sector participation in government projects.
The IMF also said Egypt should improve the transparency of economic data to improve policy debate and the business environment.
Cairo-based Beltone Financial said it broadly agreed with the IMF’s findings.
"Economic reform will be challenged by the political and social environment until late 2011," Beltone said in a note, adding that it saw the budget deficit rising to 9.1 percent in 2009/10 before declining to 7.1 percent in 2010/11.