Nov 24 2012
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Egypt's subsidies need attention after IMF deal
Anyone following Egyptian economic news is probably aware that the Egyptian government has signed a preliminary agreement with the International Monetary Fund on a USD 4.8 billion loan package to close its funding gap.
The Egyptian cabinet revealed that it is keen on finalizing a deal with the IMF as global investors would perceive this as a stamp of approval by the IMF. We suspect the major sticky issue has to do with subsidies in general and energy subsidies specifically, which seem to be 'the elephant in the room' but no one wants to risk the social implications of aggressively cutting the bill.
The country has been back and forth with the IMF several times on the loan request; first the IMF wanted to see a more stable government and political system, and when an elected president and his appointed cabinet resumed talks, it asked for a home-grown Egyptian economic program that effectively tackles the country's troubled finances both in the short term and on a more strategic level.
We assume that the IMF technical team indicated that Egyptian officials would have to implement more austerity measures and exercise higher prudence in dispensing the country's net international reserves and may not enjoy the same liberty it had to draw on it and support the currency when necessary.
Simply put, Egypt spends far more on public sector salaries, subsidies, etc. than it makes from taxes, privatization proceeds and the like. Government expenditure has been growing at a cumulative average growth rate of 16% between 2006/2007 and 2011/2012, far higher than revenue, which recorded a CAGR of only 10.8%. The overall budget deficit has widened over time, along with increasing subsidies, especially on energy.
Domestic debt as a percentage of GDP stands at 80% or so. The ratio for international foreign currency debt is much lower at 15% of GDP, which is the reason why the government has now resorted to international institutions.
Alleviation of the fiscal burden of subsidies and the need for reform has been at the core of most public finances agendas in Egypt. The topic has been advocated by politicians but it is the one thing politicians have continuously avoided tackling after they assume power.
The subsidy system started back in the 1950s with the Nasrist socialist movement where the state would be responsible to provide for the citizens' everyday needs. Six decades later, the subsidy bill is tall and wide, logging EGP 130 billion and representing 27% of total expenditure in the revised budget of 2011/2012.
According to research by the Egyptian Center for Economic Studies, energy subsidies affect resource allocation as the richest urban quintile benefits from 33% of these subsidies, while the poorest quintile benefits from only 3.8%.
Subsidy Phase-out Plan
Nonetheless, a serious plan to phase out subsidies should carefully consider the direct and indirect impacts. In any case, there should be a wide and far-reaching public education campaign to explain the problem and rationalize the reasons behind cutting expenditures. According to Magda Kandil, Executive Director and Director of Research at ECES, there are both economic and environmental benefits, such as reduction of wasteful consumption and efficient allocation of resources, reduction in greenhouse gases and encouraging alternative clean energy.
Benefits of reducing subsidies also go beyond simply cutting the expenditure bill; it should result in higher labor participation in GDP as it encourages labor absorption industries rather than energy and capital intensive industries, a much needed measure given Egypt's growing unemployment rate.
Contrary to the IMF's history in dealing with borrowing nations, the fund has repeatedly stated that they would not set pre-conditions on Egypt for the funds sought. However, that doesn't mean no strings are attached. The program should ensure that the country's resources together with donor funds will not be wasted and might set some guidelines on the usage of the country's funds and net international reserves.
Sherif Metwally, CFA, is a senior investment analyst at National Bank of Abu Dhabi's asset management group. The views expressed here are his own and do not necessarily represent those of NBAD or Zawya.
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