The Great Budgetary Expectations

CAIRO - 17 June 2018: A quick glance at the preliminary financial statement for Egypt’s 2018/19 budget shows that the government is highly optimistic about the country’s economy, targeting a 5.8 percent growth rate, compared to the current 5.2 percent, as well as slashing budget deficit from 10.9 percent in the fiscal year 2016/17 to 8.4 percent. Similarly, inflation is targeted to drop from 13 percent to 10 percent in the new budget, a rate well below the International Monetary Fund’s (IMF) estimated 15.2 percent and public debt to drop from 97 percent in the current fiscal year to 91 percent in 2018/19.

Expenditure is set at LE 1.424 trillion; of which debt interests shape LE 541, up from LE 437.9 in the current fiscal year, LE 266.09 billion for wages, LE 60 billion for purchase of goods and services, LE 332.29 billion for subsidies and social spending, LE 148.5 billion for public investment and LE 75 billion other expenses.

As for revenues, the government aims to collect LE 989 billion this year, up from LE 813.4 billion projected in the fiscal year (FY) 2017/18, marking an annual increase of 21.6 percent, through focusing policies on administrative and institutional reform in the taxation system, means of expanding tax base to boost proceeds, and ways to diversity general revenue resources.

Taxes revenues will see an annual hike of 23.4 percent to reach LE 770 billion and contribute 14.7 percent of the GDP, compared to 14.2 percent a year earlier. Other non-tax revenues will include LE 10 billion from the planned initial public offerings (IPO) of some state enterprise and capital increase in the Egyptian Exchange (EGX), LE 8.2 billion from public enterprises’ profits and LE 7.4 billion from surpluses from economic authorities, excluding the Suez Canal surpluses.

In the pre-budget, the government is also looking to raise LE 770 billion in tax revenues in the next fiscal year; a figure close to the IMF’s predicted LE 770.5 billion, but too ambitious compared to Pharos’ predictions of LE 709.3 billion.

“This figure is aggressively ambitious. The state ability to collect taxes does not meet this high expectation,” economist and Managing Director of private equity firm Multiples Group, Omar El-Shenety says.

Managing Director and Global Head of Research at EFG Hermes Ahmed Shams EL-Din highlights two positives at the budget level from a fiscal point of view. Firstly, the government is continuing to target higher tax revenues (increasing to contribute 14 percent of the GPD), and the second is its commitment to slashing subsidies.





The government’s ambitious expectations come at potentially hard times as the government prepares for a third round of energy subsidies cut by the end of the current fiscal year. This also coincides with a leap in global oil prices to reach late-2014 levels; signaling another potential wave of price inflations.

Experts agree that the government’s mission to achieve these goals will not be an easy task, and warn that some projections should be reconsidered, given the recent regional and domestic developments, to avoid a sharp budget deviation.

A steep road toward an achievable target

Although the new budget targets a 5.8 percent growth rate, the IMF estimated the GDP growth rate for 2018/19 at 5.5 percent. Economists, however, consider the government target an achievable dream as the GDP growth rate in the first half of the current fiscal year stood at 5.2 percent, and is forecasted to end the year at 5.3 percent, up from 4.2 percent in 2016/17; all figures that exceeded the fund’s targets.

This goes in parallel with a strong reform proram, and legislative reforms that aim toward a positive investment climate and resolving pending investor conflicts. Foreign direct investment (FDI) has also been steadily rising, registering $7.9 billion last fiscal year, and projected to hit $10 billion by the current one.

“The government is likely to hit all its targets on growth, inflation and fiscal deficit in FY18/19. Growth is supported by strong rebound in tourism, rising natural gas production and public investment. Consumption is also recovering gradually, supported by a catch-up in incomes,” Shams El-Din says.

But even though the targets are feasible, and various market conditions pave the way for achieving them, it will not be an easy road.

“This growth rate is ambitious, yet is not a pipe dream. The government would realize its goal if macroeconomic stability was maintained,” El-Shenety says.

As GDP growth rate was around 5 percent during current fiscal year, Shenety predicts a 5.2 percent for the next fiscal year, but he reiterated that the government’s target is “achievable.”
On the other hand, Chief Economist at HC Brokerage Sara Saada has more optimistic views, predicting the economy to grow by 6 percent in 2018/19 and 6.2 percent in the next fiscal year.

Saada adds that the private investment growth is key to more sustainable GDP growth, urging the authorities to adopt a number of monetary and fiscal policy measures to to stimulate private investment growth over the short term.

The threat of soaring oil prices

Fuel subsidies are set at LE 89 billion in 2018/19 budget; a figure well above the IMF’s requirement of LE 48.4 billion. On the other hand, Pharos Holding anticipates a further rise in fuel subsidies to reach LE 98.9 billion, as the investment bank is pricing the average Brent price at $69 per barrel, $2 above the finance ministry’s forecast.




“Budgeting a 26 percent decline in fuel subsidies and 49 percent in electricity subsidies will help further extend the fiscal consolidation with a 2 percent of GDP primary surplus in FY18/19. This would provide Egypt with a decent fiscal buffer, and also contribute in changing the structure of fiscal spending where the state will have more funds to spend on health and education,” Shams El-Din says.

Flagging fuel subsidies as the key challenge in the new budget as oil global prices have been on the rise over the past week, reaching over $75 per barrel, Shenety highlights the need to reconsider the oil pricing in the budget, given the possibility to see further hikes in the crude prices in the coming period.

Global crude oil price is a key risk as each $1 increase per Brent barrel would harm the overall budget deficit as the Egyptian General Petroleum Corporate (EGPC) would suffer a cost increase by LE 4 billion, finance ministry’s and Pharos’ estimates are similar in this regard, Pharos Holding’s economist Mahmoud el-Masry says.

HC’s Saada agrees, affirming that the increase of global oil prices, along with other external risk may jeopardize the balance between price stability and the government’s fiscal consolidation plan.

Oil prices soared more than 3 percent shortly after US President Donald Trump decided on May 8 to quit a nuclear deal with Iran, vowing the “highest level” of sanctions against the OPEC member. The decision aroused investors’ concerns about escalating risks of conflict in the Middle East and about oil supplies in the market as Tehran’s output would cut 1 million barrels daily once the sanctions take place in six months, unless other deals are reached.

On May 10, Brent crude futures went up by $2.36, to settle at $77.21 a barrel. The global benchmark hit a session high of $77.43, the highest since November 2014. US West Texas Intermediate (WTI) crude futures inched up 3 percent by $2.08 to hit $71.14 a barrel.

“A higher-than-expected increase in fuel prices could slow down the recovery in consumption and could lead to some slippage on the fiscal side; whether due to a higher interest expense or larger fuel subsidy bill,” EFG-Hermes’ head of research says.

The inflation ahead

The pre-budget’s target to bring down inflation from 13.1 percent in April’s end to 10 percent is an especially ambitious one, given the government’s pledge to move ahead with the fiscal reforms, including energy subsidies cut and the potential increase of several public services, including transportation.

Ruling out the possibility of curbing inflation to reach the target of the new budget, Shenety says: “A new inflationary wave is in the pipeline, fueled by energy subsidies cut. Inflation will most probably rebound again to the levels of 20s, but we will not see 30s again.”

Since last November, Egypt’s annual inflation started to ease gradually after peaking at 35 percent last July. However, monthly inflation edged up for the third month in a row, from 0.3 percent in February to 1 percent in March, and eventually to 1.5 percent in April, fueled as usual by the food and beverages item, which recorded a month-on-month increase in its price level of 2.4 percent, Mubasher International’s economist Israa Ahmed explains.

“Although we see annual inflation retreating, we see that monthly inflation is of more concern in the time being. We think there is an inflationary wave that is disguised under the base effect in annual inflation, yet it appears more clearly on a monthly basis,” Ahmed adds.

Considering the monthly inflation rate as a relatively high one, Ahmed says that this level raises questions about price levels in the upcoming months, especially during Ramadan and after the upcoming subsidy cuts.





The CBE targets an inflation rate of 13 percent (±3 percent) by the fourth quarter of 2018, aiming to gradually reach a single-digit rate next year.

“Inflation is already hovering around the CBE’s inflation target and we estimate that the upcoming fuel prices hikes will still leave inflation stable given the favorable base effect. Rising oil prices are the key risk to the government meetings its targets,” says Shams El-Din.

Further risks

El-Masry hints at two other major risks to the new budget as the finance ministry built its sensitivity analysis on three main scenarios: The first assumes that a depreciation in the pound-to-dollar exchange rate by LE 1 will result in a LE 3 billion decrease in the primary balance in FY2018/19, representing a decline in primary surplus as a percentage of GDP by 0.05 percent.

However, Pharos estimates show that a similar depreciation in the currency would lower the primary surplus by LE 7.6 billion, and consequently a decrease in primary surplus of 0.1 percent of GDP, Masry explains.

Shenety believes putting the dollar at LE 17.25 in the new budget is a good estimate and better than the LE 16 price of the current budget. Meanwhile, Pharos’ Masry says the average dollar-to-pound exchange rate is estimated at LE 18.63; a rate closer to the IMF’s estimate of LE 18.7 than that of the government.

The second risk highlighted by Pharos economist was the finance ministry’s estimate that a 1 percent increase in average interest rates on government securities in foreign currency would raise the interest payments by LE 4-5 billion. Pharos’ research predicts that a similar hike would push the interest payments by LE 12.2 billion.

Given those factors, economic expert and former head of both Egyptian and Arab direct investment associations Hany Tawfik calls it a “disastrous budget.” The debt interests are eating up more than LE 541 billion and the debt premiums stand at LE 243 billion; combined, they amount to LE 784 billion and shape around 82 percent of the targeted revenues set at LE 989 billion, he explains.





Egypt has managed to achieve a number of targets, including lowering inflation and increasing net international reserves to pre-2011 level, but this has come at the price of higher debt, HC’s Saada argues.“While we believe the current high level of local debt (97 percent of GDP) is a burden on the fiscal budget, we are confident that with its commitments to the reform program, fiscal consolidation plan, and our expectation of accelerating GDP growth, local debt-to-GDP should gradually drop,” she adds.

However, Saada warns that the rise in external debt to $100 billion in January, up from $67 billion in December of 2016, is a major source of vulnerability to the Egyptian economy.

Social Spending

As the government intends to press ahead with its fiscal reforms, it raised its food subsidies allocations to LE 86.2 in the new budget, up from the LE 82.2 expected during this fiscal year and more than double of LE 42.7 in 2015/16.

It also maintained allocations for unconditional financial cash support, such as Takaful and Karama social safety network program, at the same level of 2017/18; at LE 17.5 billion.

Key social schemes applied on the new budget are: Takaful and Karama, school nutritional meals, setting social insurance and low-income social protection plans, in addition to applying the new comprehensive health insurance system, which aims to guarantee fairness among participants and be self-funded and sustainable, according to the pre-budget statement.

The finance ministry also plans to increase expenditure for overhauling public services, continuing major infrastructure projects — including public transportation services, water and sewage systems, slum development and human resources developments — and increasing allocations for education, health and scientific research. Around LE 148.5 billion will be allocated for public investments in 2018/19.

The statement confirms the ministry’s commitment to reprioritize and effectuate expenditure, follow more efficient and just distribution plans, achieve the intended financial control as means to reduce public debt rates, provide more future allocations for investments and create more job opportunities.