Will the IMF loan save Egypt?
Pros and cons of the international aid package
In early 2015, the Egyptian government spent some LE 300 million on a splashy economic development conference in Sharm el-Sheikh that aimed to win back the confidence of foreign investors. A few months later, President Abdel Fattah el-Sisi unveiled a LE 64-billion upgrade to the Suez Canal, which not only aimed to dramatically increase canal revenues (despite the predictions of skeptical analysts who pointed to a decline in worldwide shipping traffic) but promised to transform the canal region into a global shipping industry hub, attracting private developers to the special new Suez Canal Economic Zone, where businesses would enjoy all kinds of investment incentives. However, to date, the SCZone has attracted just one firm, China’s state-owned TEDA, a developer that has been in talks with Egypt about the plan since before the 2011 revolution. Despite the state’s high-profile efforts, new foreign investment to Egypt in fiscal 2015/16 totaled $112 million less than the year before.
In recent months, with no cards left to play, Egypt finally went ahead with painful but long-awaited economic reforms that had long been recommended by the International Monetary Fund. With a new value-added tax and a free-floating, much devalued pound, Egypt hopes to send a strong message to foreign investors by finally gaining IMF approval for a three-year extended fund facility worth $12 billion, the largest such loan to a MENA country. “This loan gives foreign investors the right message and assurances that we are committed to reforms, and that these reforms are the right ones,” said finance minister Amr el-Garhy at a November
press conference. While both the IMF and the government have taken pains to portray the recent austerity measures as 100-percent Egypt’s idea, it’s broadly accepted that the IMF conditioned the money on pulling the trigger on politically sensitive measures like subsidy cuts and devaluation of the currency. “The IMF will heavily influence the government’s economic policies in the coming period,” says Sherif el Diwany, former head of Egyptian Center for Economic Studies.
The IMF’s prescription for healing Egypt’s economy—which has suffered deeply in the wake of the political turmoil that began in 2011—centers on cutting bloated government costs and increasing revenue. In September, a new 13-percent VAT replaced Egypt’s old 10-percent general sales tax. Then there was the Central Bank’s surprise decision to allow the beleaguered pound, which had sunk to record lows against the dollar on the forex black market, to trade at market rates. In just one day after the Nov. 3 float, the currency plummeted 73 percent—from LE 8.8 to the dollar to more than LE 15. Not coincidentally, the following day, the government hiked fuel prices by 30 to 47 percent. A month later, for the second time in 2016, Egypt sharply hiked customs duties on some 320 categories of goods deemed “non-essential,”—including cosmetics, refrigerators and electric shavers—in an attempt to encourage domestic production and curb a ballooning trade deficit. This only added to the anxiety of Egyptian consumers, who were already facing double-digit inflation.
In the wake of all this, some analysts and local officials have opened fire on the IMF, arguing that such austerity policies which will lead Egypt to ruin, essentially throwing out the baby with the bathwater by obliterating local purchasing power. However, former Minister of Finance Ahmed Galal— who argued against a proposed $4.8 billion IMF loan during his tenure in 2013 because he believed the austerity measures it prescribed would ultimately keep the local economy from flourishing—points out that the IMF is simply an international lending agency focused on macroeconomic stability; it’s the state’s job to provide a social safety net, to “come up with an agenda to achieve social justice and protection in addition to economic growth.”
Price increases are hitting all walks of life, but, as always, the poor will feel the impact the hardest. “Low-income, and now middle-income individuals are the ones who are paying the price for such fast-paced reforms,” says Mohamed Reda, CEO of Solid Capital, which is working on a report for a local restaurant chain on local consumer patterns. Trade Economics, a website, predicts that inflation could pass 20 percent by mid-2017. “For the first half of 2017, the expectation is for inflation to be over 20 percent,” agrees Amr el Alfy, global head of research at Mubasher Financial Services.
Businesses will have to weigh how much of these cost hikes they can pass on to their customers without risking a substantial drop in sales. “My costs have gone up by 100 percent on the back of recent ‘reforms’ ending with the floating of the pound,” grumbles Ahmed Zaghloul, the CEO of October Pharma, which, like many local firms, depends on imported raw and semi-finished materials to produce medicines, mainly for the local market. Some analysts believe the government’s strategy may indeed be a boon to local industry, as manufacturers are driven to use cheaper inputs from local suppliers as the cost of imports skyrockets. “We might actually see higher demand for local products as imports become too expensive,” says Alfy.
He believes that the adverse economic impact of higher prices, though painful, will be temporary. “A shortterm drop in consumption will not be a major deterrent,” says Alfy. This sentiment was echoed by, Philippe Le Houérou of the International Finance Corp., who visited Egypt midDecember for the first time to sign three financing agreements to support local enterprises, including $20 million to developer Hassan Allam Holding plus $10 million for Algebra Ventures and $2 million for Flat6Labs, outfits that encourage local startups. “Egypt has tremendous long-term potential, given its large workforce, strategic location and well-established manufacturing sector,” Le Houérou told reporters during his visit. “The country's recently announced economic reforms will help it capitalize on that promise by breathing new life into the private sector, which can drive innovation and employment and create lasting opportunities for all Egyptians.”
“WITH THE IMF PROGRAM, THE GOVERNMENT IS THE STUDENT AND THE IMF IS THE TEACHER AND THE STUDENT NEEDS TO FOLLOW INSTRUCTIONS.”
Mainly, the idea of the IMF loan is that it’s a signal to potential investors that Egypt is serious about making economic reforms. “The government for the past five years has consistently failed to pass meaningful reforms due to societal pressure and weak political will,” says Ihab el Desouky, head of the Economics department at the Sadat Academy for Management Sciences. He cites Egypt’s recent foreign currency and commodities shortages as some of the unfortunate consequences of such dithering. “With the IMF program, the government is a student and the IMF is the teacher. And the student needs to follow the instructions of his instructor,” says Desouky, adding, “This is a good thing.” Unconditional aid such as the assistance Egypt received from the Gulf in recent years only encouraged the government to kick the can further down the road without solving any of its fundamental problems.
And of course, the $12 billion will at least provide some more wiggle room. According to the finance minister, the first tranches of IMF cash will go directly
to the national treasury to support Egypt’s foreign reserves, which stood at around $23 billion by the end of November—up from a critical level of $15.5 billion at the end of July but still well below the $36 billion of the pre2011 era. In interviews with local media, CBE Governor Tarek Amer stressed that the money would not be spent defending the pound in order to prevent devaluation and runaway inflation, as it was in recent years. "Intervene? No. Absolutely not. This is history. There will be no intervention,” Amer told state-owned Al Ahram in December. In an interview with Enterprise, an online business news round-up, the CBE governor said: “We want this newborn child to start standing on its own feet and supporting itself.”
However, some worry about how Egypt will manage when the time comes to repay the IMF loan, which will be paid back over 10 years at an interest rate of between 1.55 and 1.65 percent. Egypt has also borrowed an additional $7 billion from other international sources such as the World Bank and the African Development Bank as part of the overall international financial aid program. This should bring Egypt’s total foreign debt to around $75 billion, up from $39.8 billion at the start of 2016. “This is an unprecedented level of foreign debt,” says Adly. “The government doesn’t really address the elephant in the room, which is from where will this money be paid back, with interest? We are now in a loop where we’re taking out new loans to pay for old loans.” On top of its general foreign debt, Egypt is also imminently planning to borrow $25 billion from Russia to build a nuclear power plant.
Mohamed Zakaria, a member of parliament, adds that Egypt needs to do a lot more to make its business climate attractive to international investors than “pass laws and restrictions that increase the cost of doing business in Egypt.” He notes that Egypt was ranked a lackluster 122nd out of 190 countries in the World Bank’s latest Doing Business Report. “Encouraging existing and potential investors, at home or abroad, doesn’t happen just because we have a lot of foreign currency reserves in the Central Bank,” says Zakaria, who mentions that Egypt needs to improve business procedures pertaining to things like paying taxes, enforcing contracts and trading across borders.
So far, the government hasn’t launched any comprehensive plan to protect the poor from rising prices in the wake of recent measures. Hany Helmy, chairman of Al Shorouk Securities, says that the government could have done much to reassure Egyptians and the business community following the slew of recent reforms by simply presenting some contingency plans. “Having any sort of solid ground is vital for potential investors, and they are definitely eager to come given how favorably the stock exchange reacted to the news,” says Helmy, who nonetheless cautions that the health of the stock market is not necessarily indicative of longer-term investment enthusiasm or the health of the overall economy.
Khaled Abdel Fattah, a finance professor at Ain Shams University, raises the dark example of Argentina’s economic collapse at the turn of the 21st century, which many blamed the IMF for helping set off the crisis. “I am worried because I am seeing similarities between what is happening now in Egypt and what happened in Argentina,” says Abdel Fattah. The South American country’s public debt grew enormously during the 1990s, but the IMF kept lending it money and extending its payment schedules. A 2004 report by the Independent Evaluation Office of the IMF criticized the international lender for supporting Argentina's exchange rate policy that pegged the peso to the dollar for too long—which caused its debt to balloon out of control and ultimately forced the government to declare the largest sovereign debt default in history in early 2002. Despite concerns raised by others, for now, Egypt’s foreign debt is still at a relatively reasonable level, argues Alfy. “Egypt’s debt is almost equal to its GDP, but only about 15 percent of that debt is in foreign currency,” he explains.
Analysts say much depends efforts to promote investment in Egypt that complements the IMF loan, which officials hope to do with a proposed new comprehensive investment law, for example. “Right now Egypt is set for massive economic growth,” says Passant Fahmy, a retired banker who lectures on economics in local universities pointing to positives like the 2015 discovery of a “supergiant” natural gas field off Egypt’s Mediterranean coast and “the fact that Egypt’s exports are cheaper than they have ever been.” She says: “The government now has a very simple task: create what investors perceive as a businessfriendly environment.”