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Mar 25 2009

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Egypt economy: Outlook - Pressing on with reform, liberalisation

The government's overriding concern in 2009/10 will be how to maintain economic activity in a climate of rapidly slowing global economic growth. Even so, there is little doubt that the government will continue to press on with economic reform and liberalisation. Measures introduced so far include sharp cuts in income tax rates and customs duties and a widening of the tax base. The government has begun to reduce fuel subsidies in order to let domestic prices gradually converge with world market prices. However, the combined impact of high domestic inflation and the global downturn has led the government to reverse the energy price increases until end-2009.

Given the collapse of lending in global financial markets, the government's consolidation programme in the banking sector has been prescient, and Egypt's banks should by and large be able to weather the downturn. The government will continue to tighten regulation and work on improving access to finance for the private sector, but the sale of Banque du Caire , the second state-owned bank slated for privatisation, has been put on hold, and may not proceed until 2010. The government is aware of the risk of social dislocation if liberalisation moves too quickly, and reform will remain gradual rather than abrupt. Strikes and protests against privatisation have led the government to put its privatisation programme on hold temporarily. The government is working to introduce public-private partnerships in areas such as schools and hospitals in order to continue to improve Egypt's infrastructure.

Rising food and energy prices pushed up government expenditure in fiscal year 2007/08 (July 1st-June 30th), with subsidy spending reaching E£84bn (US$15bn). In 2008/09 large increases in public-sector wages will lift expenditure. Moreover, in late November the finance minister, Youssef Boutros-Ghali, announced an additional E£15bn fiscal stimulus package to boost economic growth, which will further increase expenditure.

Spending will also be pushed up by high interest payments on the public debt stock, which (including public external debt) was estimated at 101% of GDP at end-June 2007. Although revenue growth was broadly on target in the first seven months of 2008/09, it is likely to ease over the remainder of the fiscal year as domestic economic growth slows and world trade drops sharply. A large proportion of tax receipts is derived from global trade, in the form of revenue from either the Suez Canal or customs duties. With global trade growth expected to contract in 2009, revenue may fall below the government's projections. In 2008/09 measures to increase tax compliance, a rise in the sales tax on cigarettes and the abolition of some tax exemptions will boost revenue. In 2009/10 a new property tax of 10%—which has been postponed to January 2010 from January 2009—should also help lift tax receipts.

The impact of the government's fiscal package should be broadly contained, owing to these additional revenue-raising measures, and we forecast that the fiscal deficit will widen only marginally from 6.8% of GDP in 2007/08 to 7% of GDP in 2008/09. Given the government's caution over contracting foreign debt, we expect the deficit to be financed largely by local borrowing. With few signs of a rapid economic recovery, the government has announced its intention to carry forward its fiscal stimulus into 2009/10, and assuming the measure is passed by parliament, we forecast that the budget deficit will widen again, to 7.2% of GDP.

The Central Bank of Egypt (CBE) has begun to move towards making inflation-targeting its main policy goal. It will be some time, however, before the CBE 's monetary instruments are fully in place. Inflation has eased over the past three months, and the CBE cut interest rates for the first time in three years on February 12th by 100 basis points, taking the overnight deposit and lending rates to 10.5% and 12.5% respectively. With global commodity prices having fallen fast, and economic growth slowing, we expect the CBE to continue to cut rates over the next 18 months. We expect rates to be cut by a total of 200 300 basis points by mid-2010, but the CBE will be cautious rather than aggressive in cutting rates.

SOURCE: Country Report