It's budget season again, with stimulating growth, boosting revenues, cutting energy subsidies and boosting social spending and investment being the highlights of the 2018-19 budget, as outlined by Minister of Finance Amr Al-Garhi to MPs early this week. With spending estimated at LE1.4 trillion and revenue targets of around LE990 billion, the government will not have it easy, but it is aiming high. It is targeting a growth rate of 5.8 per cent of GDP and cuts in the unemployment rate to between 10 and 11 per cent. It hopes to reduce the budget deficit to 8.4 per cent of GDP in 2018/2019 and achieve a primary surplus of two per cent of GDP and reduce public debt to 91 to 92 per cent of GDP. It seeks to achieve a 10 per cent inflation rate. “The growth rate target is ambitious but achievable,” said Omar Al-Shenety, managing director of Multiples Group, a private equity firm in the MENA region. As the growth rate during the current fiscal year is hovering around five per cent, according to Al-Shenety, the 5.8 per cent target “is not far-fetched, especially in the light of heavy government investments in mega-projects and the expected recovery in private investment on the back of the reductions in the cost of borrowing.” Continuous boost from government investments coupled with household consumption gradually bouncing back as purchasing power improves are the factors that should see that growth target being achieved, said Allen Sandeep, director of research at Naeem Holding. The government has allocated LE148 billion for investment in the new budget, marking a 43 per cent increase on last year's level. Experts believe that government investment has been among the main drivers of growth in the economy in recent years. The New Suez Canal, the New Administrative Capital, thousands of kilometres of roads connecting various parts of the country, and fisheries and agricultural projects are some of the mega-projects executed by the government since 2014. The launch of the mega-projects was intended to be a means of reviving of the economy, stagnant since 2011, since they have involved pumping in investment. In its economic outlook released on Monday, the World Bank forecast real GDP in Egypt to grow by five per cent in fiscal year 2018-2019 and to increase gradually to 5.8 per cent by 2020-2021. It expected growth to be driven by resilient private consumption and investment, public investment, and a gradual pickup in exports, notably of gas, as well as improvements in tourism. However, reducing the budget deficit to 8.4 per cent as compared to the 10 per cent targeted for the current fiscal year could be easier said than done. To achieve it, according to the pre-budget statement issued by the Ministry of Finance last week, the government will be working on increasing revenues while restructuring public spending to create the fiscal space for spending on social services. It hopes to increase revenues to around LE990 billion, a 22 per cent increase on what is expected for the current year. Increasing tax revenues is also planned, though this will not be achieved by imposing new taxes but by the better administration of existing ones such as the value-added tax (VAT) and the property tax. Tax revenues are targeted to come in at LE770.28 in the new budget. Sandeep believes this is achievable. “As far as I see, tax revenues in fiscal year 2018 have been higher than the state's pre-anticipated number. I expect the numbers for fiscal year 2019 to be in-line with the budget.” Privatisations Another planned source of revenue is offering stakes in state-owned companies to the public through the stock market, with the government aiming to collect LE10 billion in 2018/2019 through such plans. The Finance Ministry released a list of 23 state-owned companies in March that will either sell shares via an initial public offering (IPO) or increase the percentage of free-floating shares on the stock exchange. Some of the companies in the programme are already listed, and most of those slated for privatisation are profit-making and should see a stake of 15 to 30 per cent of equity going into private hands. The list ranges from banking and petroleum to real estate and industry, with names like cigarette producer Eastern Tobacco and real estate companies Heliopolis Housing and Medinet Nasr Housing included. Banque du Caire is also on the list. “I believe the government can very easily get billions of pounds in privatisation receipts because the commodities [companies] they are offering are good ones and from different sectors,” Al-Shenety said. Another positive aspect is that part of the plan means raising the capital of some state companies, giving them the space to expand their activities and maybe recruit new people. The programme would also energise the market, which has been hungry for new share-issues for some time, Al-Shenety said. Meanwhile, the government is moving on with its plan to trim spending on energy subsidies. Subsidies on fuel will be cut by around 21 per cent, leaving total spending at around LE89 billion in the new budget. Electricity subsidies will witness a more drastic cut of around 45 per cent. Energy subsidy cuts are part of plans made when the government acquired a $12 billion extended fund facility (EFF) loan from the International Monetary Fund in November 2016. According to the IMF, Egypt's fuel-subsidies bill has decreased from a peak of 5.9 per cent of GDP in 2013-14 to 3.3 per cent in 2016-17. It is expected to decline further to 2.4 per cent of GDP in 2017-18. The government has committed to implement the next fuel price increase by December 2018, according to the IMF. It has also committed to periodically increase the pre-tax cost-recovery ratio on most fuel products, in order to achieve 100 per cent in 2018/19 and to eliminate electricity subsidies by 2020-21. With these subsidy cuts on the horizon, many people are once again bracing themselves for the worst, expecting a general spike in prices. “The expected subsidy cuts, based on our estimates, should have a four per cent incremental impact on headline Consumer Price Index,” said Sandeep. The government estimates inflation to reach 10 per cent at the end of the fiscal year, while the average inflation rate for the year is set at 13.2 per cent in the budget statement. However, Al-Shenety believes this figure is unachievable. “We expect one or two hikes in energy prices through the coming fiscal year. There is no way the government can rein in the resulting inflationary pressures to the neighbourhood of 10 per cent,” he said. Estimates made by local investment bank Pharos put inflation at 13.8 per cent by the end of 2018-2019, while the IMF expects 15.2 per cent. Al-Shenety agrees with estimates of 15 per cent or less, ruling out the possibility of reaching last year's record of above 30 per cent inflation. “This happened due to the fact that a number of reform plans, including devaluation, subsidy cuts and the introduction of new taxes, were implemented in one shot and thus had a combined effect on inflation,” he explained. The Egyptian pound lost 50 per cent of its value against the US dollar in November 2016, and inflation reached a record high of 33 per cent in July 2017. It began cooling over the past couple of months, falling to around 13 per cent in March, the lowest level since May 2016. The cooler inflation has encouraged the Central Bank of Egypt's (CBE) Monetary Policy Committee (MPC) to cut rates. Since the floatation and the subsidy cuts in November 2016, the CBE has raised interest rates by seven per cent to encourage more people to hold onto their pounds. However, since February 2018 it has cut overnight deposit and lending rates twice to reach 16.75 per cent and 17.75 per cent, respectively, at the end of March 2018. Some experts believe that the expected spike in inflation could push the CBE to increase interest rates again. However, Al-Shenety points out that the highest inflationary wave is behind us, and it is time to encourage investment by lowering interest rates again. He points to another factor that makes lowering rates inevitable, namely the cost of local debt. Each one per cent increase in interest rates costs the government millions of dollars in debt payments, he said. The government has put the rate on treasury bills at 14 per cent in the new budget, compared to 16 to 18 per cent in the current fiscal year. Foreign investments in Egyptian treasury since the devaluation in November 2016 until March 2018 have come in at $23 billion. As for fears that the expected decline in interest rates could make the treasuries less appealing, Al-Shenety points out that even if these were lowered to 14 per cent this would still be much higher than those in many developed and emerging economies. Social spending While funds saved by the fuel subsidy cuts could have been directed towards more social spending, this will not be the case, according to the government statement. Funds dedicated towards social spending are set to be around LE332 billion in the new budget, only an LE1 billion increase on the current year. The government has also reinstated its commitment to move from a commodity-based subsidy system to cash transfers to the neediest. It has stressed its commitment to the new universal healthcare system that will begin to be implemented in the new fiscal year. According to the government statement, a third of the budget deficit will be financed through international sources, namely the IMF loan and Eurobonds and some bilateral loans, while the rest will be financed through treasury bills and bonds. In 2018-19, Egypt should receive the third tranche of the IMF loan, equaling $4 billion over two tranches. The government issued Eurobonds worth $11 billion during the period from January 2017 to February 2018. Earlier this month, it closed a two billion-euro Eurobond sale, the first Eurobond issue denominated in euros. It is targeting issuing LE128 billion (around $7 billion) worth of Eurobonds in 2018-19. The IMF loan, together with the borrowing from international markets, has meant a ballooning of the country's international debt. Egypt's foreign debt stood at around $80 billion, according to the Ministry of Finance, in September 2017. This has since increased by around $7 billion because of the value of the Eurobonds issued since January 2018. It is a huge growth in external debt, which stood at $46 billion in June 2014. But how can the government's deficit shrink with the higher debt service? Sandeep said this can be achieved from the saving from the fuel and electricity subsidy cuts, the proceeds from government IPOs as well as the expected faster economic growth. The pre-budget report issued by the Ministry of Finance highlights a number of challenges that the government could face in implementing the new budget, including changes in international oil prices, interest rates and international trade. The government has drafted the budget on the assumption that oil prices will settle at around $67 per barrel. An increase of one dollar in prices will cost the government LE4 billion in expenditures and will thus be translated into a wider budget deficit. Moreover, this increase in expenses would limit the money available to the government to finance capital and social expenses in the light of the increases in international prices, eating up the health and education allocations. Any upward movement in the value of the dollar, especially in the light of the expected upping of interest rates by the US Federal Reserve, would negatively affect flows to emerging and developing countries including Egypt. The effect of such moves could be exacerbated as Egypt is planning to issue $6-7 billion worth of Eurobonds during the next fiscal year. Egypt would thus have to increase the rate on its debt to make it more attractive to investors. A one per cent increase in the yield on the bonds would result in an increase in expenses by $4-5 million. As for the expected decline in the international trade growth rate due to tensions between the US and China, the pre-budget report expects each one per cent drop in the growth rate to strip the government of LE980 million due to declines not only in Suez Canal receipts but also in the resulting declines in customs and import tariffs. *This story was first published in Al-Ahram Weekly
