A n International Monetary Fund (IMF) team led by Mission Chief for Egypt Chris Jarvis is visiting Cairo from April 30 to May 11 to conduct the first review of Egypt’s economic reform program - a test Egypt needs to pass to obtain the second tranche of its $12 billion IMF loan.
The mission comes at a critical time as the country passes through the more difficult phase of the reform program, with prices soaring since the the flotation of the Egyptian pound on November 3.
Indeed, floating the pound, introducing a value-added tax and slashing fuel subsidies are just some of the conditions Egypt had to meet in order fto secure the $12 billion extended facility from the IMF. Shortly after the loan’s approval, Egypt received a first tranche of $2.7 billion last December.
IMF Middle East and Central Asia Department Director Jihad Azour said the IMF agreement with Egypt helped instill strong confidence back into the Egyptian economy. This translated into strong capital inflows, which helped stabilize the economic situation.
What we have done and what we still need to do
Leading London-based independent macroeconomics research, analysis, forecasts and consultancy firm Capital Economics expected in a research paper that Egypt will pass the first IMF review, but bigger tests are yet to come.
“The Egyptian government has probably made sufficient progress to pass the upcoming review of its IMF program and receive the second tranche of its $12 billion loan,” the report said. “Investors are likely to welcome this, but we think there will be bigger hurdles for the government to overcome in the next couple of years…The Egyptian authorities will face bigger tests of their commitment to economic reform.”
In order to pass the review and receive the second tranche, the Egyptian government is required to undergo a series of procedures. In this regard, Capital Economics highlighted three key areas where the government has made good progress in recent months.
First, a new stamp duty on stock exchange transactions was approved and scheduled to come into effect in May at an initial rate of 0.125%. The levy is predicted to generate LE 1 to LE 1.5 billion.
The second area of progress was the CBE halting its financing of the budget deficit by converting a large chunk of the government’s credit facilities into financial securities and limiting the level of outstanding credit to the government to LE 75 billion, down from a recent peak of LE 485 billion.
Lastly, in an effort to improve the transparency of policymaking, the CBE published the first quarterly “Monetary Policy Report” at the end of March. In this report, the CBE temporary factors as the causes of the recent surge in inflation, including the 50% plunge of the pound against the dollar since November. Capital Economics adds “this supports our view that, despite the current high rate of inflation, the next move in interest rates will be down.”
On the other hand, there has been slow progress in some areas, including energy sector reforms and financial statements on state guarantees. Reforms of the industrial licensing system have also yet to be implemented.
That said, a second round in subsidy cuts is expected by the IMF, which has always stressed on the importance of continuing the reform agenda. “I think the right sequence is to address inflation and then pursue some of the additional fiscal measures that were part of the program,” said Azour.
The sequencing of measures includes eliminating subsidies on most fuel products during the program period, Head of Pharos Holding’s Research Department Radwa el-Sweify tells bt.
While further fiscal consolidation will likely be needed to curtail the budget deficit which remains high at around 11.5% of GDP, the government seems unwilling to apply further austerity measures amid fears of rising public anger. Egyptians had taken to the streets in some governorates in March to protest the Supply Ministry’s decision to scale back the amount of bread that can be sold to those not holding a smart card for subsidized bread. In this sense, further subsidy cut remain one issue that could become more controversial at future reviews.
Soaring inflation
Egypt was hit by soaring inflation over the past six months, registering a three-decade high of 30.9% by March-end year-on-year, although the monthly rate started to ease. The government is expected to apply further reforms in the coming months, which may include an additional fuel subsidy cut and an increase in electricity prices.
“Egypt still shows abnormally high Y-o-Y inflation, as it did not yet get over the inflationary impact of the November 2016 (float) decision,” said Mubasher International’s economist Esraa Ahmed. “We expect this to persist until the base effect fades out.
However, declining M-o-M inflation and a somehow stable urban inflation rate may bring some hope that soaring prices may come under control before the year’s end.”
In a meeting with Egypt’s President Abdel Fatah al-Sisi in Washington on the sidelines of his visit to the White House earlier in April, IMF Managing Director Christine Lagarde admitted the pains of the ambitious reforms which pushed inflation rates to more than a 30-year high. “We recognize the sacrifices made and the difficulties faced by many Egyptian citizens, especially due to high inflation.”
The fund is not only admitting the social and economic risk of soaring price pressures, but it also vowed to work with the authorities to curb inflation and protect those struggling to secure their basic needs after the flotation. “The IMF is working to help the government and the Central Bank to bring inflation under control and supports the steps the Egyptian authorities are taking to protect its poorest and most vulnerable citizens,” Lagarde added. Similarly, Azour affirmed that the main focus over the coming period is on how to bring inflation down.
“Bringing inflation down is a priority, not only for monetary policy management, but also for economic and social issues,” he said.
Increasing interest rates is not the answer
To keep inflation under control, the fund alluded to the need for further interest rate hikes.During the joint meetings between the IMF and the World Bank, held in Washington on April 21, Azour hinted that Egypt should use monetary and fiscal instruments, including interest rates, to curb soaring inflation.
“We believe that the utilization of the interest rate instrument is the right instrument to be used in order to keep inflation down, and this is something that we are discussing with the authorities,” said Azour.
The Central Bank of Egypt (CBE) had raised the interest rates on November 3, the same day it floated the pound, by 300 basis points (3%) in an attempt to support the local currency against the U.S. dollar as well as fight dollarization. The CBE has kept interest rates unchanged since then.
Economists, however, argue that the monetary policy tool is not projected to be effective anymore in containing inflation that is driven, not by an increase in demand, but rather by higher production costs after the flotation and other reform measures.
“The IMF seems to be pushing Egypt to keep interest rates high in a bid to curb inflation,” el-Sweify says. “We believe that interest rates will actually remain stable, or at current levels, until the fourth quarter of 2017, when we can start to see potential cuts.”
EFG-Hermes, Middle East and North Africa Senior Economist Mohamed Abo Basha, agrees with el-Sweify. “We believe the hike will not bring inflation down. It is too difficult to take action to control this inflation; nothing but a stronger pound would take it down. This requires a boom in revenues from tourism as well as foreign direct investments,” he explains.
Since December 2015, the CBE raised the rates by 6%, raising the cost of government debt without an effective impact of inflation, Abo Basha tells bt.
Abo Basha further notes that the inflationary pressures will likely inch up further as the IMF is predicted to push for raising the rate of the VAT and reducing fuel subsidies. He urges the government to strengthen the social safety networks and increase cash subsidies for the most vulnerable and those benefitting from this system.
Instead of increasing interest rates, Abo Basha suggests more flexibility from the IMF. “We expect the program review to focus on rescheduling the reforms and the timeframe. The fund should show some flexibility since the Egyptian authorities have achieved most of the targets agreed upon during the program’s first six months; cutting the fiscal deficit, increasing foreign reserves and maintaining a flexible exchange rate regime.”
Table: Selected Prior Actions & Structural Benchmarks
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