During the past 40 years, deciding to change subsidies — first brought in during the Nasserist era — has always been every government's bugbear for fear of societal backlash. As a result, subsidies kept growing more in size while declining in efficiency, with over 80 per cent going to benefit the wealthiest 20 per cent of the population, and some 20 per cent wasted through the black market. After many statements to prepare Egyptians for belt-tightening policies, and the president's refusal to ratify the draft 2014/2015 state budget, due to its high deficit allowance, the government hastily slashed fuel subsidies on petrol, diesel and natural gas, along with electricity and power supply to certain industries. Addressing Egyptians Monday, President Abdel-Fattah Al-Sisi asked Egyptians to support the decision, which he described as urgent in order to save the country. He put the current subsidies cost to the government at LE400 million a day, with interest on the deficit costing another LE600 million per day. Al-Sisi added that in addition to the recent Gulf aid of $900 million, Egypt would need to borrow LE250 billion this year. Double-digit fiscal deficit in each of the last three years has pushed government debt to over 90 per cent of GDP, from 76.6 per cent at the end of fiscal year 2010/2011, contributing to a series of downgrades to Egypt's international credit ratings. The subsidy bill, which is dominated by fuel products, accounted for 12 per cent of GDP. The moves came as part of a package to limit expenses and increase revenues through imposing new taxes on stock market gains, on revenues realised by Egyptian individuals and companies abroad, and a temporary income tax on those earning more than LE1 million annually. This was accompanied by another increase in cigarette and alcohol taxes, and putting a ceiling on the maximum wage for state employees at LE42,000. How these steps will impact the man in the street is the most important question. “Since Mubarak, and till recently, talk about subsidies hovered around replacing the subsidies with cash hand-outs for those who need it. But what is happening now is gradually cancelling the subsidies without taking any steps on the other level — an approach that will throw more Egyptians into poverty due to the resulting inflation,” said Samer Attallah, professor of economics at the American University in Cairo. Safiya, a cleaning lady who has to change three microbuses everyday to go from her home in Al-Nahda, in East Cairo, to Heliopolis where she works, said that since the beginning of the week she pays LE1.50 instead of LE1 to reach each of her three stops. “This means my daily transportation expenses increased by LE3,” she said. Safiya, who is the only breadwinner of a family of three daughters and a jobless husband, said that in the three days following the announcement of the new decision, the prices of vegetables and fruits jumped by 10-30 per cent in the market near her home. “I can't afford further increases. I am already cutting my purchases of sugar needed for homemade Ramadan sweets, so that my budget covers the increased expenses.” The government does not deny the inflationary effect of subsidies cut, with the minister of planning expecting that the increase in fuel prices together with the indirect effect of higher input costs would push inflation to double digits. A consumer protection association expects the increase in prices over the coming period to be 200 per cent. The government is trying to rein in prices by meeting with syndicates of microbus drivers, representatives of the Chambers of Commerce and Federation of Industries, and big retailers in Egypt to make gentlemanly deals not to increase prices. In his speech, Al-Sisi asked street vendors and microbus drivers to help him in making the effect of the subsidies reduction less agonising. However, “it is very hard to reign in prices as around 40 per cent of the Egyptian economy is in the informal sector, like street vendors that you can't monitor,” said Fakhri Al-Fiki, professor of economics at Cairo University. Hani Genena, Head of research at Pharos Securities, sees the inflationary pressure as temporary. He explained that higher energy prices would trigger a one-off increase in prices as producers and service providers pass on higher production and transportation costs to consumers, pushing inflation rates up in July. Nevertheless, with decreased consumption, producers will find themselves trapped and won't be able to sustain the rate of price increases without risking not selling their products. The inflation caused by postponing the decision, and thus to resorting to printing money to finance the increased deficit, would have been much higher, according to Genena. On the positive side, Fitch, the American ratings agency, released a note Tuesday saying that the recently announced fuel price hikes was an important step towards reducing Egypt's substantial fiscal deficit — a key rating weakness. It added that the mandate secured by President Al-Sisi following his election victory in May, and the effective containment of much of the opposition, means the political environment is more conducive to fiscal consolidation. Egypt suffered credit rating downgrades more than five times during the past three years. Securing a better rating would enhance Egypt's negotiating power vis-à-vis any future loans, leaving the cost of borrowing less. Moreover, the recent subsidies move, coming in line with reforms called for by the IMF, means Egypt is getting closer to qualifying for an IMF loan, even if the government has not expressed its intention to get such a loan. “Such a development (acquiring an IMF loan) could trigger strong financing from other international entities, such as the World Bank, European Union, and US and African development banks, especially after the donors conference that is expected to be held in the next few months,” according to a note issued by Prime Holding, a local investment bank. Having better credit worthiness will increase Egypt's appeal as an investment destination and will result in an inflow of foreign direct investment, foreign capital, as well as liquidity in the capital market. Another gain for the economy, according to Prime researchers, is that phasing out subsidies will encourage foreign oil and gas companies operating in Egypt to increase their investment. “This is because with a lower subsidies bill, the government is much more capable of paying back the $6.5 billion it owes to these companies.” However, more needs to be done. “The new move on its own will not fix the economy's problems, as further reforms will be needed to put public finances onto a more sustainable footing,” said Jason Tuvey, assistant economist at Capital Economics, an independent macroeconomic research group. “But it is at least encouraging that the new government has acted early and boldly, which bodes well for the prospect of additional reforms,” he added. Tuvey explained that all in all, the recently introduced measures should, according to various government sources, reduce energy subsidy expenditure by LE50 billion, or 2.5 per cent of GDP, leaving a deficit of 9.5 per cent of GDP. There are still some other areas that need to be addressed, including curbing the public sector wage bill and cutting food subsidies. This should be accompanied, over a longer horizon, with measures to improve the business environment and fix the country's decrepit education system, if Egypt is to enjoy a sustained period of economic growth of around 5-6 per cent a year. However, in light of the outcry that the fuel hikes have spurred, Al-Fiki, who worked with the IMF for a time, believes that what is more important now is to introduce a package to enable the poor to cope with the effects of such moves, and should include narrowing the gap in salaries, introducing a progressive taxation system that levies more from the rich, and widening the social insurance pension system. Otherwise, the current administration could lose its popularity in the street. Capital Economics' Tuvey sees it differently. “All in all, President Al-Sisi's popularity will probably take a hit following the subsidy cuts. But if there was a time for him to introduce such bold measures, it is now, when his popularity is still high.”
