It is July and the beginning of Egypt's fiscal year. This year's budget is special as it reflects the bold economic reforms that the government has been following since last November when it finalised a $12 billion loan deal with the International Monetary Fund (IMF). The deal will see Egypt receiving the loan in instalments provided that the periodical assessment of the IMF team before the disbursement of each tranche proves it is sticking to the reforms. These aim at slashing the budget deficit by reducing subsidies, increasing the value-added tax (VAT) rate by one per cent to 14 per cent, in addition to upping fees on some services like car licences as well as increasing levies on cigarettes. The projected deficit in the budget comes in at 9.1 per cent compared to 10.8 expected for 2016/2017. With subsidies previously representing almost 25 per cent of the government's overall expenses, reducing this item, though sensitive politically, is at the core of the reform programme. The government reduced the subsidies last week for the third time since 2014. As part of the IMF deal, it has vowed to reduce energy subsidies to 20 to 25 per cent of their level in July 2014 over a three-year period. “This is part of the government's effort to narrow a high unsustainable budget deficit, which will help cure the macroeconomic imbalances in Egypt. The timing of the decision was anticipated ahead of the traditional high consumption season in the summer,” stated a research note issued by local investment bank Pharos Holding. According to the decision, the price of 80-octane petrol, the most widely used by microbuses, tuk-tuks, and vehicles used in transporting agricultural products, increased by 55 per cent to reach LE3.65. The price of 92 octane petrol increased from LE3.6 to LE5. However, the highest increase came in the price of butane canisters, widely used in houses across Egypt, with prices doubling to reach LE30. The moves have saved the government LE45-50 billion in energy subsidies in the 2017/2018 budget to reach LE105-115 billion, according to a Ministry of Finance statement. The value of the energy subsidies after the recent steps represents seven to eight per cent of public spending, compared to 20 per cent before they were implemented. The bulk of the savings will be directed at ration-card subsidies, which will increase from LE47 billion to LE85 billion, Ahmed Kouchouk, deputy minister of finance, was quoted as saying in the statement this week. The new budget also includes the introduction of another 30 per cent reduction in electricity subsidies as part of a five-year plan to phase out the subsidies that started in 2014. While the government insists that increases in electricity prices do not target poorer people, as they do not belong to the high consumption brackets that pay the highest bills, the figures show that electricity costs are becoming a heavier burden. A study by the Egyptian Initiative for Personal Rights (EIPR), an NGO, highlights the fact that increases in electricity prices over the last four years have reached 160 per cent. Those belonging to the lower consumption brackets shouldered 167 per cent in increases over four years, it said, while those belonging to the middle classes saw a 190 per cent increase in the cost of electricity. Such increases, according to the EIPR, increased the burden on Egyptian households as electricity bills now represent 2.6 per cent and 2.3 per cent of monthly household expenses for the poor and those on limited incomes, respectively. This exceeds average spending in rich countries like the US, where it is 2.15 per cent. The reductions in the subsidies are set to increase inflation by four to five per cent, according to Prime Minister Sherif Ismail, an outcome that could feed social unrest in a country with almost 40 per cent of the population living under the poverty line. The inflation rate has been hovering around 30 per cent over the last three months, its highest level since 1986. However, the government has defended the move as inevitable, saying it has been thoroughly studied and was preceded by social-friendly measures that aimed at cushioning the effect of the increases. Kouchouk explained that monthly bonuses of LE130 paid to employees in the government's administrative apparatus, in addition to deductions on income taxes, would together translate into a monthly increase in salaries of LE200. Moreover, the increase in ration-card allowances from LE21 to LE50, effective on 1 July, translates into a LE125 increase in subsidised food allowances for a family of five, he said. Added to the above-mentioned LE200, Egyptian families are now getting a LE325 increase in income per month, he said. Earlier this month, the government also raised pensions and increased the threshold of taxable incomes as well as increasing the allowances that beneficiaries of the conditional cash transfer programmes Karama and Takaful can receive monthly by LE100. While the decrease in energy subsidies will tighten the budget deficit by 1.2 per cent, according to Prime Securities calculations, a local consulting firm, this will make up for the cost of financing these social spending schemes together with the effect of the increase in interest rates by two per cent last month that added a monthly amount of LE2.5-3 billion to debt servicing. Ballooning interest payments remain one of the shortcomings of the budget, as they now eat up one-third of government expenses at LE381 billion, a 25 per cent increase on last year's figure. The Central Bank of Egypt (CBE) has increased interest rates by a total of five per cent since November in a bid to contain inflation. Its expansion in borrowing through treasury bills has inflated local debt figures to almost 100 per cent of GDP, upping debt service payments to unprecedented levels. Meanwhile, the increase in the dollar exchange rate from LE8 last year to LE18 currently has doubled foreign debt payments. Moreover, the foreign debt itself has increased to $67 billion, fed by loans from a number of financial institutions including the World Bank, the IMF, and the African Development Bank, in addition to two Eurobond offerings of a total value of $7 billion made during 2016/2017. The government hinted earlier this week that it is considering another $1-1.5 billion Eurobond offering during the current fiscal year. Spending on social services, according to the budget, meets the constitutional requirements of four per cent of GDP being spent on health and four per cent on education. While the value of wages increased by 4.2 per cent in the 2017/2018 budget to reach LE239.5 billion, its percentage of GDP declined from seven per cent last year to 5.8 per cent in the current year. This complies with the recommendations of the IMF, as according to the agreement increases in the wage bill must be contained below the projected level of inflation and generate fiscal savings equivalent to 0.9 per cent of GDP. The World Bank before disbursing the first tranche of its $3 billion loan to Egypt stipulated that the figure should come in at below seven per cent of GDP. On the revenue side, tax revenues come in at LE603 billion in this year's budget, reflecting the introduction of a further one per cent in the VAT rate to reach 14 per cent as well as the new stamp tax duty on stock exchange transactions. The implementation of the VAT will continue to pay off in 2017/2018, according to Pharos, as taxes on goods and services rise to LE263.3 billion versus LE220.1 billion in 2016/17. The VAT was introduced last year at a 13 per cent rate to replace the older sales tax. This year, the rate will increase by one per cent to reach 14 per cent. Amr Al-Monayer, a deputy to the minister of finance, said that the one per cent increase in the VAT would have a very limited effect on the prices of taxable commodities and would have no effect at all on the 57 commodities that are exempt from the tax. These include food, transportation, healthcare and education services. Pharos also estimated that income tax revenue would rise to 6.3 per cent of GDP in 2017/2018 as economic activity picks up, in addition to a higher contribution from the Egyptian General Petroleum Company to the budget due to accelerated gas production and higher than budgeted oil prices. “The current low tax-effective rates prove that the most appropriate approach to raising more revenues in the Egyptian case would be through a more efficient tax-payment system, rather than tax rate hikes,” Pharos said. It gave by way of example what happened in 2016/2017 when corporate tax payments rose from 4.1 per cent of GDP to 6.6 per cent in reaction to a tax rate cut and improved tax-collection procedures. The VAT represents almost 40 per cent of this year's expected tax revenues. According to EIPR analysts, this by default hurts the poor and those on limited incomes mainly because they spend more of their incomes on basic needs. Meanwhile, those with higher incomes spend less as a percentage of their total incomes, giving them the luxury of saving. Direct taxes like the sales tax and VAT are imposed on spent incomes and not on saved, which is why they hurt the poor more, the analysts said.
