|23 June, 2018

Egypt's fuel subsidy reform credit positive

The price hikes will cut the fuel subsidy bill to 1.7% of GDP in 2019

Image used for illustrative purpose. A worker fills the tank of a car at a petrol station in Cairo

Image used for illustrative purpose. A worker fills the tank of a car at a petrol station in Cairo

REUTERS/Mohamed Abd El Ghany

CAIRO — Egypt’s new government, which was sworn in last Thursday, increased fuel prices by 35.0%-66.6% last Saturday with immediate effect.

The price hike is part of the reform agenda agreed with the International Monetary Fund (IMF) and will help Egypt meet the agreed target for a fiscal deficit of 8.4% of GDP in fiscal 2019, which ends in June 2019, from around 9.8% of GDP in 2018.

The implemented price hikes are credit positive.

The price hikes will cut the fuel subsidy bill to 1.7% of GDP in 2019 from the government’s projection of 2.5% of GDP in the current fiscal year, and will help reduce the overall subsidy bill from its estimate of 7.5% of GDP in 2018 to 6.5% in 2019, Moody’s Investors Service said.

Under a no-change scenario, newly appointed Finance Minister Mohamed Maeet indicated that the fuel subsidy bill would have increased to EGP180 billion (3.5% of GDP) by fiscal 2019 because of the increase in oil prices, thereby jeopardizing the government’s planned fiscal consolidation. The authorities plan to eliminate all fuel subsidies (excluding on liquefied natural gas) by the end of 2019 as per the government’s reform program agreed with the IMF.

As a compensating measure, Maeet announced a 15% increase in pensions starting in July. The minimum pension will increase to EGP750 from EGP500, which will cost the government EGP21.3 billion (0.4% of fiscal 2019 GDP). The new government is also working on expanding more targeted cash transfers instead of wholesale subsidies that mostly accrue to the wealthier segment of the population, for instance via the Takafol and Karama cash transfer programs launched in 2015.

The most recent price hike follows earlier price increases in electricity, transportation and tap water of 25%-250%. The fuel price hikes are the third since the flotation of the currency in November 2016, which led to a 45% currency depreciation in real effective terms, followed by surge in annual inflation to a peak of more than 34% in July 2017 and which since then has returned to 11.4% in May 2018 (see Exhibit 2). In August 2016, the government introduced a value added tax on goods and services at an initial rate of 13%, and increased it to 14% in July 2017.

Although external competitiveness, foreign-exchange reserve coverage and the economic growth outlook have benefited greatly from the devaluation and the switch to a flexible exchange rate system, the population has borne the brunt of the subsidy reform adjustment costs in the form of declining purchasing power, especially over the past year. The comparison of nominal weekly wage growth at 11.5% in 2017 with an average inflation reading at 30.7% points to a sharp deterioration in real wages over the past year.

Similarly, the World Bank’s poverty impact analysis suggests that the welfare loss from previous energy price increases was around 5.5% of household expenditure on average before any mitigating measures.

We account for the risk of reform fatigue in the population by assigning a high domestic political event risk assessment to Egypt’s credit profile in light of the potentially significant effect on public finances if reforms were reversed. However, in our view the brightening economic and employment outlook in Egypt provides a better basis for acceptance of the new reforms by highlighting the economic benefits of successful reform implementation after an inevitable adjustment phase. — SG

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