May 2012
Egypt's FY2012/13 budget is sure to be among the most important - and difficult to formulate - in the history of the country. Coming amid the worst economic slump since the currency crash of 2003, Prime Minister Kamal El Ganzoury faces the daunting task of balancing pressing social needs with sufficient financial sustainability to reassure international creditors.
Central Bank of Egypt (CBE) data shows that next year's budget will be introduced after 12 months of unprecedented depletion of international reserves from $36 billion to $16 billion and a ballooning budget deficit expected to equal 10 percent of GDP, up from an earlier forecast of 8.6 percent. Meanwhile, the banking system is exhausted from financing almost 90 percent of government needs during 2011, forcing the CBE to reduce provision levels by 200 basis points for more leeway to cover new T-bill issuances. And if that were not enough, net foreign direct investment during the first quarter of FY2011/12 was almost half what it was a year earlier. Casting a pall over the dreary economic data are the government's fitful negotiations with the International Monetary Fund (IMF) over a possible $3.2 billion loan.
"We are now in a much worse position than we were 12 months ago," says Magda Kandil, executive director and head of research at the Egyptian Center for Economic Studies.
Several structural problems that have burdened public financing for years make negotiating the budget even more challenging. During FY2011/12, almost 75 percent of total expenditures went for social spending. Of that 75 percent, a third went for subsidies and social insurance, a quarter for salaries of government employees and about a fifth to service debt.
By far the most expensive is the blanket energy subsidy, which is expected to cost LE 100 billion in the current fiscal year, about 20 percent of all government spending. "We have a monster that has been created over the years," says Kandil. "It defies every principle of good government practices and social justice." She points to the fact that 80 percent of heavy consumers of energy can afford to pay the market price.
Nonetheless, neither Kandil nor Hany Genena, head of research at Pharos Securities, advocates an abrupt end to the subsidy given the current state of Egypt's economy. "If we can save LE 10-20 billion in energy subsidies every year, we would be rid of the monster," says Kandil. The government must begin to address the issue now, says Genena, noting that the General Petroleum Authority is approaching its credit limit with banks. "This is alarming," says Kandil.
Clearly, the FY2012/13 budget must look significantly different from the current budget. "If this doesn't happen, the government will completely crowd out the private sector because banks will not have the resources to finance both," says Genena, adding that a lack of available credit would seriously hamper private sector growth.
Also, unless the government shows it is serious about tackling long-standing problems, the IMF is not likely to approve a loan. That would send an unambiguous message about the risks of investing in Egypt. "We would have to rely on ourselves, at which point the CBE would be forced to print money and the currency would crash because you will have no foreign currency inflow," Genena adds.
Acknowledging this critical situation, El Ganzoury has said on various occasions the FY2012/13 budget should target an LE 20 billion reduction in spending, of which LE 5 billion would come from a 33 percent cut in subsidies to energy-intensive industries, such as steel, cement and ceramics; capping public sector salaries at 35 times the minimum wage (provisionally set at LE 700 per month); and reducing administrative costs.
El Ganzoury proposes to increase revenue from an estimated LE 230 billion this year by selling surplus property and increasing the price of exported natural gas. However, he has postponed implementation of a real estate tax and new pension laws set to take effect in January because they have not been approved by parliament. "This is a tight budget rather than an austerity budget," says Kandil. And with parliamentary supervision, she is confident the next budget will "cut out all the waste."
However, parliament must ensure that the FY2012/13 budget is flexible enough to accommodate such external factors as commodity price spikes with a devalued domestic currency.
During the current fiscal year, energy price fluctuations increased the cost of fuel subsidies by an estimated LE 20 billion to LE 115 billion, 21 percent more than expected. Coupled with GDP growth of 0.3 percent in the first half of the current fiscal year, energy subsidies could easily exceed the original target of 9 percent of GDP, according to Magda Shalaby, economics professor and department head at Banha University. Adds Genena: "I wouldn't be surprised if other [commodity and energy price] hikes happen during 2012."
The second factor will be the IMF's conditions for approval of the $3.2 billion loan; those conditions have not been made public. Kandil explains that the IMF is a major international lender that requires its funds to be used to support long-term economic sustainability. "The aim [of the IMF] is not to punish the people or government," she says.
Several experts see IMF loan approval as a sign of how committed the government is to reforms that would encourage private and sovereign investment.
Egypt needs about $12 billion to return to normal deficit and reserve levels, according to government estimates. "The $3.2 billion will be an assurance that the currency will not explode in the following three to six months, so at least [foreign] T-bill investors would regain some confidence and move back into the market," says Genena. "This confidence will spill over to [long-term] FDI. Even with an austere or limited budget, investors will come if the IMF approves." It also might reduce the pressure on banks and free up credit for the private sector, he adds.
Despite the apparent benefits of adhering to IMF conditions, parliament is resisting, insisting that there are domestic options for financing the FY2012/13 budget. According to Shalaby, opponents of the loan point out that it would add to the country's debt-servicing costs, even with a 1.5 percent annual interest rate. "No one wants that... especially with servicing costs estimated to reach LE 110.8 billion with the new budget, compared to LE 87 billion in FY2011/12," she says.
Without the loan, the government will be strapped for cash, especially with low foreign currency inflow for everything from short-term T-bills (where the foreign component dropped to LE 3.8 billion in January 2012 from LE 57 billion a year earlier) to long-term FDI (in January, half what it was in 2011), according to CBE data.
Shalaby suggests alternative domestic financing channels. The first is to continue the current borrowing policy set in the 1990s by the World Bank and IMF to bridge the deficit via revenue-generating government spending, though she acknowledges that this channel is reaching its limits.
The second alternative is to limit public spending, which accounts for 75 percent of total government spending. "This would have direct impact on national income and price levels," she says, noting that it will be critical to minimize the negative impact on healthcare, education and social security. "In [FY2011/12], budget cuts didn't help the less fortunate." This alternative would require policy changes, such reducing the country's dependence on oil and linking public sector salaries to job performance.
The third channel is to combine the ministries' private investment funds, whose proceeds are now distributed at the discretion of individual ministers. "Pooling all these funds will require a strong regulatory framework to constantly audit and manage these funds to prevent corruption," says Shalaby.
Her fourth suggestion is to decentralize many government functions to the governorates. "Going down this road will create more equality among different governorates as well as a sense of responsibility and accountability, as limited assistance would be provided from the central government," explains Shalaby.
Under existing regulations, the budget should have been sent to parliament for approval in mid-April. But by late last month, only the budget briefing had been presented to the People's Assembly, which rejected it because it showed no clear plan to move out of the current economic crisis, according to Mohamed al-Omda, an independent member of the assembly. It is widely speculated that the current government is delaying the process until a president is elected in June, at which point the new government would be responsible for negotiating and implementing the FY2012/13 budget.
Regardless of how the next budget is structured, Shalaby says, as long as it is sustainable and transparent, with proper governance, it will go a long way toward eliminating past inefficiencies.
For Kandil, the IMF loan needs to be part of a well-structured budget, and Genena believes that a fully financed budget and political stability would reduce the need for immediate, substantial structural reform. "However, five years down the line these structural problems will have to addressed, so it is better to start now and gradually fix them," he says.
Egypt's FY2012/13 budget is sure to be among the most important - and difficult to formulate - in the history of the country. Coming amid the worst economic slump since the currency crash of 2003, Prime Minister Kamal El Ganzoury faces the daunting task of balancing pressing social needs with sufficient financial sustainability to reassure international creditors.
Central Bank of Egypt (CBE) data shows that next year's budget will be introduced after 12 months of unprecedented depletion of international reserves from $36 billion to $16 billion and a ballooning budget deficit expected to equal 10 percent of GDP, up from an earlier forecast of 8.6 percent. Meanwhile, the banking system is exhausted from financing almost 90 percent of government needs during 2011, forcing the CBE to reduce provision levels by 200 basis points for more leeway to cover new T-bill issuances. And if that were not enough, net foreign direct investment during the first quarter of FY2011/12 was almost half what it was a year earlier. Casting a pall over the dreary economic data are the government's fitful negotiations with the International Monetary Fund (IMF) over a possible $3.2 billion loan.
"We are now in a much worse position than we were 12 months ago," says Magda Kandil, executive director and head of research at the Egyptian Center for Economic Studies.
Several structural problems that have burdened public financing for years make negotiating the budget even more challenging. During FY2011/12, almost 75 percent of total expenditures went for social spending. Of that 75 percent, a third went for subsidies and social insurance, a quarter for salaries of government employees and about a fifth to service debt.
By far the most expensive is the blanket energy subsidy, which is expected to cost LE 100 billion in the current fiscal year, about 20 percent of all government spending. "We have a monster that has been created over the years," says Kandil. "It defies every principle of good government practices and social justice." She points to the fact that 80 percent of heavy consumers of energy can afford to pay the market price.
Nonetheless, neither Kandil nor Hany Genena, head of research at Pharos Securities, advocates an abrupt end to the subsidy given the current state of Egypt's economy. "If we can save LE 10-20 billion in energy subsidies every year, we would be rid of the monster," says Kandil. The government must begin to address the issue now, says Genena, noting that the General Petroleum Authority is approaching its credit limit with banks. "This is alarming," says Kandil.
Clearly, the FY2012/13 budget must look significantly different from the current budget. "If this doesn't happen, the government will completely crowd out the private sector because banks will not have the resources to finance both," says Genena, adding that a lack of available credit would seriously hamper private sector growth.
Also, unless the government shows it is serious about tackling long-standing problems, the IMF is not likely to approve a loan. That would send an unambiguous message about the risks of investing in Egypt. "We would have to rely on ourselves, at which point the CBE would be forced to print money and the currency would crash because you will have no foreign currency inflow," Genena adds.
Acknowledging this critical situation, El Ganzoury has said on various occasions the FY2012/13 budget should target an LE 20 billion reduction in spending, of which LE 5 billion would come from a 33 percent cut in subsidies to energy-intensive industries, such as steel, cement and ceramics; capping public sector salaries at 35 times the minimum wage (provisionally set at LE 700 per month); and reducing administrative costs.
El Ganzoury proposes to increase revenue from an estimated LE 230 billion this year by selling surplus property and increasing the price of exported natural gas. However, he has postponed implementation of a real estate tax and new pension laws set to take effect in January because they have not been approved by parliament. "This is a tight budget rather than an austerity budget," says Kandil. And with parliamentary supervision, she is confident the next budget will "cut out all the waste."
However, parliament must ensure that the FY2012/13 budget is flexible enough to accommodate such external factors as commodity price spikes with a devalued domestic currency.
During the current fiscal year, energy price fluctuations increased the cost of fuel subsidies by an estimated LE 20 billion to LE 115 billion, 21 percent more than expected. Coupled with GDP growth of 0.3 percent in the first half of the current fiscal year, energy subsidies could easily exceed the original target of 9 percent of GDP, according to Magda Shalaby, economics professor and department head at Banha University. Adds Genena: "I wouldn't be surprised if other [commodity and energy price] hikes happen during 2012."
The second factor will be the IMF's conditions for approval of the $3.2 billion loan; those conditions have not been made public. Kandil explains that the IMF is a major international lender that requires its funds to be used to support long-term economic sustainability. "The aim [of the IMF] is not to punish the people or government," she says.
Several experts see IMF loan approval as a sign of how committed the government is to reforms that would encourage private and sovereign investment.
Egypt needs about $12 billion to return to normal deficit and reserve levels, according to government estimates. "The $3.2 billion will be an assurance that the currency will not explode in the following three to six months, so at least [foreign] T-bill investors would regain some confidence and move back into the market," says Genena. "This confidence will spill over to [long-term] FDI. Even with an austere or limited budget, investors will come if the IMF approves." It also might reduce the pressure on banks and free up credit for the private sector, he adds.
Despite the apparent benefits of adhering to IMF conditions, parliament is resisting, insisting that there are domestic options for financing the FY2012/13 budget. According to Shalaby, opponents of the loan point out that it would add to the country's debt-servicing costs, even with a 1.5 percent annual interest rate. "No one wants that... especially with servicing costs estimated to reach LE 110.8 billion with the new budget, compared to LE 87 billion in FY2011/12," she says.
Without the loan, the government will be strapped for cash, especially with low foreign currency inflow for everything from short-term T-bills (where the foreign component dropped to LE 3.8 billion in January 2012 from LE 57 billion a year earlier) to long-term FDI (in January, half what it was in 2011), according to CBE data.
Shalaby suggests alternative domestic financing channels. The first is to continue the current borrowing policy set in the 1990s by the World Bank and IMF to bridge the deficit via revenue-generating government spending, though she acknowledges that this channel is reaching its limits.
The second alternative is to limit public spending, which accounts for 75 percent of total government spending. "This would have direct impact on national income and price levels," she says, noting that it will be critical to minimize the negative impact on healthcare, education and social security. "In [FY2011/12], budget cuts didn't help the less fortunate." This alternative would require policy changes, such reducing the country's dependence on oil and linking public sector salaries to job performance.
The third channel is to combine the ministries' private investment funds, whose proceeds are now distributed at the discretion of individual ministers. "Pooling all these funds will require a strong regulatory framework to constantly audit and manage these funds to prevent corruption," says Shalaby.
Her fourth suggestion is to decentralize many government functions to the governorates. "Going down this road will create more equality among different governorates as well as a sense of responsibility and accountability, as limited assistance would be provided from the central government," explains Shalaby.
Under existing regulations, the budget should have been sent to parliament for approval in mid-April. But by late last month, only the budget briefing had been presented to the People's Assembly, which rejected it because it showed no clear plan to move out of the current economic crisis, according to Mohamed al-Omda, an independent member of the assembly. It is widely speculated that the current government is delaying the process until a president is elected in June, at which point the new government would be responsible for negotiating and implementing the FY2012/13 budget.
Regardless of how the next budget is structured, Shalaby says, as long as it is sustainable and transparent, with proper governance, it will go a long way toward eliminating past inefficiencies.
For Kandil, the IMF loan needs to be part of a well-structured budget, and Genena believes that a fully financed budget and political stability would reduce the need for immediate, substantial structural reform. "However, five years down the line these structural problems will have to addressed, so it is better to start now and gradually fix them," he says.
© Business Monthly 2012
