For better or worse, a $12 billion IMF loan is on Egypt’s doorstep alongside a hefty dose of austerity. The question is: can we ride out the storm?
by Bahaa Ghaffar
On the trading floor of a fast-paced brokerage firm in a high-rise building overlooking Cairo, the IMF loan is on everyone’s lips. The excitement is palpable. Brokers and traders are optimistic once more with the hope of an increase in investments from abroad. Amid all the excitement, Salah the office boy is quietly clearing coffee mugs. Asked if he's heard about the IMF loan, Salah says, “I haven’t really been following the news. I don’t know about this IMF organization, but I’ve heard we are getting $12 billion from abroad. Didn’t we just get $9 billion last year? Where did that go? Where are the improvements? Health and education, food and drink, electricity and gas - everything is getting more expensive," he says. "The rich are getting richer and the poor are getting poorer.”
Egypt’s economy has been teetering on the brink since 2011. While the January 25 uprising ousted former president Hosni Mubarak, it also left the economy reeling. Five years, and a second uprising later, Egypt is still in the midst of an economic slump faced with rising inflation, increasing public debt and an unemployment rate of about 13% and an even higher youth unemployment rate of about 23%. There is also a significant foreign currency crisis, with Egypt’s foreign reserves at $15.5 billion, less than half of what they were before the uprising. Political instability has worsened the situation, making tourists and foreign investors shy away. Tourism is at an all-time low with no signs of recovery. This has left Egypt starving of foreign currency, with most of its sources severely diminished.
After weeks of negotiations, the International Monetary Fund (IMF) confirmed last month a $12 billion loan to Egypt over 3 years pending the IMF's approval. An IMF mission led by Chris Jarvis, the mission chief for Egypt, had visited Cairo on July 30 to discuss terms of the loan as well as support for the government’s economic reform program, in response to a request from the Egyptian authorities. Jarvis said that while, “Egypt is a strong country with great potential,” it also has “some problems that need to be fixed urgently,” effectively putting an end to months worth of speculation, as well as many conflicting official reports.
What does the loan mean?
Those with high incomes have excess money that will allow them to absorb the coming shock, especially with much of their wealth in the form of real estate and US dollars, Founder of Multiples Group Omar El-Shenety writes in Al-Shorouk. On the other hand, El-Shenety says, those with limited income will grow in numbers and fare much worse.
“Official statistics indicate that 1.5 million families went under the poverty line in 2015 alone. Moreover, as the size of this segment increases, and as prices insanely rise (greatly surpassing wage increases), this class is gradually moving to absolute poverty,” he warned, adding that this segment has no savings and no legal ways to increase their income. “Some will go to charity organizations for help, while others will turn to illegal acts. As for youth, they will seek to immigrate abroad, most probably through illegal channels.”[caption id="attachment_522684" align="alignnone" width="620"] Omar El-Shenety[/caption]
The middle class has always been the bastion of Egypt’s social and economic security, as it prefers stability to change even when faced with challenges, El-Shenety adds. He warns the middle class will see its purchasing power rapidly erode, leading to impoverishment. "A good part of it will annually fall below the poverty line to join the limited income classification, as happened last year."
"The middle class relies on a static income that is hard to raise. As their purchasing power erodes, they will face huge problems and will be unable to head to charity organizations for help as they will be overburdened with aiding the even poorer," El-Shenety says. "This change might prompt the children to reject this and maybe even revolt over worsening conditions ... Perhaps it is wise that these youth now work to greatly reduce their spending and focus on necessities to make it through this critical period, which may last for years before the fruits of economic reform start to materialize.”
How did we get here?
“This has not happened only over the last 2 years. It’s been a longer-term development,” former deputy prime minister for economic development Ziad Bahaa El-Din says. If we look at the last 5 years, the growth in public debt has been very steep primarily as a result of growth in government salaries, social spending, the subsidy component and the cost of the annual servicing of the debt.
“Those three items alone make up around 80 percent of the government’s spending, which is way beyond anything that allows enough money for investment and developing infrastructure. This has been happening for a while, but over the last 2 years there has been money coming into Egypt and there has been an opportunity to turn this around,” Bahaa El-Din says.
Still, Bahaa El-Din thinks a lot of the money is going to mega projects and huge infrastructure projects, which are currently not the best idea. “These may be very useful in the long term, but it’s not clear they should be a priority now. This has put additional strain on the dollar requirements and on public spending in general,” he says.
This, the state of tourism and the fact foreign investment has failed to pick up have put the country in a difficult position, Bahaa El-Din says.
The economy has also been hit by several negative external shocks. A decline in remittances from earnings abroad, declining foreign investment and slower growth have led the economy to suffer. This has resulted in dangerous levels of public debt, increasing from LE 1.6 trillion to LE 2.6 trillion in the last 2 fiscal years alone, with external debt increasing from $46 billion to $53 billion. Overall, as a percentage of GDP, public debt has increased from 95 percent to 100 percent. The budget deficit has exceeded 11 percent of GDP, and inflation is at 14 percent. The Egyptian pound has also weakened by about 45 percent against the US dollar in the parallel market.
Up until recently, Egypt had turned to the Gulf for aid to the tune of about $30 billion over the past couple years. Getting more funding now will be difficult as GCC countries face their own economic challenges due to low oil prices. With the government’s hands tied, a nation wary of IMF funding in the past has nowhere else to turn. Any worries that IMF provisions go against the principles of national sovereignty seem to have been set aside.
According to Jarvis, the IMF loan will indeed be supported by comprehensive reforms, soon to be voted on by parliament. And while some of these reforms might be overdue, the significance of the social repercussions is not lost on the current administration. In his first public remarks since the loan was confirmed, President Abdel-Fattah el-Sisi seemed aware of the pressures of the upcoming reforms and the challenges faced by those before him.
"The first effort at reform came in 1977. And when it was not accepted by the citizens, all the governments hesitated to make reform efforts, afraid of the reactions. It is not only you who will judge me. God will also judge, and so will history," Sisi said during a speech in Alexandria. "I will not hesitate for one second to make all the difficult decisions that many hesitated and were afraid to make over many years."
Although the full terms and the extent of the reforms of the IMF loan are yet to be released, most of its outline has taken shape. The program calls for the reduction of energy subsidies, namely raising electricity prices for households by an average of 42 percent, and eliminating industrial subsidies. It also calls for freezing government wages and imposing a value-added tax and further devaluating the Egyptian pound while encouraging internal and external loans.
Who’s afraid of the IMF?
The IMF could advise Egypt on its path to economic recovery. Instead of fretting over the loan's provisions, some welcome the guidance, transparency and sense of urgency the IMF would bring to long-postponed reforms.
“It is an exaggeration to assume these reforms are IMF driven. The truth is most of the reports don’t reveal the full extent and details of the program. All we have seen is the outline that came out in the official statement," Bahaa El-Din says. "But on the whole, these are measures that have been pursued by the government for the last 3 years and therefore they’re not IMF driven. The gradual reduction of energy subsidies and the new taxation, particularly VAT, are government policies."
The relative freeze or attempt to reduce the growth of government salaries was also a government policy before discussions with the IMF, Bahaa El-Din says. “Those elements are government policies and they should be looked at as such. The IMF will bring much better monitoring and much more transparency in where the budget is going, how the money is being spent and so on. It will also probably bring some decisions about the foreign currency issue, where clearly the management has been hesitating for a long time. But on subsidies, wages and taxation, I think this was already part of the government’s own program."
“The fact this is over 3 years and not a one-shot facility over 1 year is positive news," says Radwa El-Swaify, head of research at Pharos Holding. "It means the government will be committed to follow all the reforms and macroeconomic policies agreed upon with the IMF, there will be follow-up from the IMF and they’re going to continue to inject regular funds every year or every six months, depending on the transfer they agree on. This means there will be regular support for Egypt in tandem with the proper implementation of the macroeconomic reform program.”
The only way out?
In the face of such austerity, many ask if accepting the loan is the right decision.
“I think we’re past the point of supporting the loan or not supporting it," Bahaa El-Din says. "We are unfortunately in a situation where we have very few options. Egypt is in need of external help. It’s quite necessary at this stage because Egypt needs to try to close a big financing gap. It needs the money, it needs the advice and it needs the support of other institutions, not just the IMF. It also needs donor countries outside the IMF because the financing needs are actually bigger than those $12 billion.”
El-Swaify agrees. “The IMF loan is critical because our financing gap over the next 3 years is around $30 billion and unfortunately the dollar earners for Egypt are not doing well. Tourism and Suez Canal revenues are down. Investor appetite and investor confidence in Egypt is very low and not going to pick up soon. Plus, portfolio inflows are down to almost nonexistent, whether in fixed income markets or equity markets. Honestly, we have no chance now to get or earn US dollar financing from abroad except by tapping the IMF.”
According to El-Swaify, this sends a signal to investors that “we are going to have a macroeconomic program that the government is going to be committed to follow over the next 3 years. It’s not about being positive or negative. It’s about the fact we’ve reached a very critical stage and unfortunately we need this kind of help to get back on track.”
But maybe it should have never come to this point. Ahmed Galal, managing director of the Economic Research Forum and former finance minister, is critical of the path that led Egypt to this position, but insists on the loan’s significance.
“The government had an opportunity to present a more ambitious reform program to parliament, which it did not. The presented program was modest in its targets regarding fiscal consolidation, public debt reduction and currency stability. A combination of this modest program and reluctance on the part of the GCC to provide Egypt with further unconditional financial support meant that going to the IMF was inevitable,” Galal says. “I would have preferred a homegrown reform program that is not only ambitious but also socially balanced in terms of who pays for the reform. I was not in favor of an IMF program when I was in government because the IMF program is contradictory by design, and the Egyptian economy was already in a slump. An IMF program would have slowed down economic growth further and pushed unemployment up. We also had the resources at the time to implement an expansionary fiscal policy without creating an inflationary pressure because of the prevalence of excess capacity. Now the circumstances are different.”[caption id="attachment_522682" align="alignnone" width="620"] Ahmed Galal[/caption]
But not everyone thinks it’s too late for an alternative. “We have better alternatives that the government has ignored, and we have rushed to sign an agreement with the IMF,” Gouda Abdel-Khalek, professor of economics at Cairo University and former minister of solidarity and social justice, writes in Al-Ahaly. “Economically, this program may bring some positives, such as attracting foreign investment into the stock market. But I think there will be more disadvantages.”
Abdel-Khalek is worried the loan will generate a tidal wave of high costs, further impoverishing the lower and middle classes, as well as being detrimental to social justice. “Egyptians will be stripped of their property for the benefit of the public,” he says. He suggests revising government spending (most notably official visits and celebrations), and postponing or canceling many major projects. Instead of the purported value-added tax, he proposes a progressive income tax system and reworking the tax on profits from stock transactions. Abdel-Khalek thinks Egypt should enact limits on imports per its World Trade Organization membership rights, and should strive to reopen all factories that have shut down.
Economist Galal Amin agrees. “Egypt’s current situation with the IMF is not only a source of sorrow and pain, but also quite surprising not only in terms of Egypt’s position, but also the IMF’s position toward Egypt,” he writes in Al-Ahram, comparing the situation to a smoker who can’t stop coughing and goes to the doctor’s only to find him happily chain-smoking. The cure, the doctor (in this case the IMF) suggests, “is not for the patient to stop smoking and drinking, but to take out one of his kidneys!”
“Sure the kidneys are diseased from all the drinking, but they are not completely hopeless," Amin writes. "Plus, I have a very bad feeling that this doctor is suspiciously involved with organ traffickers.”
Will the loan be enough?
The short answer is no. “It is our responsibility to make sure that the details of the agreement are consistent with efficiency, sustainability and equity," Galal says. For example, agreeing to raise the prices of some services may be justified to cover costs, but what if these costs are due to mismanagement? ... In short: the devil is in the details.”
He notes that IMF-supported programs typically focus on macroeconomic stability; economic growth, job creation and social justice are not the primary concern.“It is our responsibility to come up with two other reform agendas: one for economic growth and another for social justice.”
According to Galal, economic growth would require serious improvements in the business environment and better utilization of capacity. He believes social justice would require adopting initiatives to improve the quality and access to education and health services, pension reforms and possibly unemployment insurance.
With fiscal and economic reforms on the scale of those suggested by the IMF, there is always the fear of short-term ramifications. The IMF agreement suggests policies that obligate the government to reduce subsidies and limit social spending. A devaluation of the currency might raise inflation even higher. In the short-term, this is likely to raise prices, straining the middle and poor classes further as they continue to struggle with poor public services and high costs of living.
All of this begs the question of whether these reforms are bad for the poor.
“Fiscal reform and economic reform in themselves are not necessarily worse for the poor,” Bahaa El-Din says. “The poor do not benefit from a weak economy, a collapsing currency and a sense of economic insecurity, which everybody has been living with for the past couple of years. It’s important to dispel the notion that economic reform of the IMF type is necessarily detrimental to the poor. What makes it detrimental is when it's combined with a lack of transparency and specific choices that favor the rich over the poor.”
Bahaa El-Din believes better government policies in spending are not bad for the poor. "If you continue to spend on highways that will take the rich to their summer resorts and not on smaller roads that will take you to Upper Egypt, then that is a social choice and has nothing to do with the IMF," he says. "This is your own governmental choice. Of course there will be an increase in prices and there will be a reduction in social spending. It will be tough for everybody. But it is up to the government to make the right choices that should alleviate this, because it need not necessarily be all borne by the poor.”
Where do we go from here?
The discussions on the IMF have exposed Egypt’s economic malaise: stalling on key fiscal and monetary reforms, slow implementation of new policies, the lack of transparency and the absence of a focused economic plan. It is clear that reforms are needed and overdue.
“We’ve been postponing,” El-Swaify says. “A lot of reforms agreed upon with the IMF are ones the government has been talking about for ages. We’ve all known the government will apply the value-added tax - it’s been on the table forever. They haven’t taken any serious steps to implement it. Civil service has been on the table forever. In terms of tax restructuring, there has been talk of increasing the tax base or the sources of tax. Encouraging more of the informal sector to be formalized in order to raise more taxes - we've been talking forever about all of these things, but there have been no serious steps taken by the government to actually implement these reforms.”
It remains to be seen if the IMF can speed up reforms. "With the implementation of the government reform program, together with the help of Egypt’s friends, the Egyptian economy will return to its full potential," Jarvis said during the IMF's closing remarks on the loan. "This will help achieve inclusive job-rich growth and raise living standards for the Egyptian people.”
Real economic improvement will lay in the government's ability to adhere to an honest, considerate and serious reform program, regardless of the IMF loan, Bahaa El-Din says.
"What worries me is we seem to be debating only in terms of whether we should or shouldn't sign the agreement with the IMF. The truth is we are going to end up signing it anyways because our choices are limited. But that should not be the end of the debate," Bahaa El-Din says. "Once it's signed, it’s extremely important that society as a whole keeps on putting pressure on the government to reveal the information and to declare what is going on, to help us monitor the progress of this program - and to help us evaluate if some aspects could be better handled.
I think it would be a very grave mistake to think it’s all a yes or no situation, and that once the deed is done and the agreement is signed we can just forget all about discussing it."