Dealing with the budget deficit will need more than a nip here and a tuck there, writes Niveen Wahish The issue of the budget deficit has resurfaced. Last week the government underlined the need to try to keep the deficit down, while drawing out the 2010/11 budget. According to international standards, the budget deficit should not exceed three per cent of GDP, says Fakhry El-Fiki, professor of economics at Cairo University and former International Monetary Fund (IMF) assistant executive director. Before the global crisis the government had succeeded in lowering it from nine per cent to 6.9 per cent, but the slowdown brought about by the crisis dictated an expansionary policy where increased spending was recommended. The targeted budget deficit for 2009/10 is 8.4 per cent. El-Fiki explains that since the onset of the global crisis the government was faced by the challenge of disbursing a stimulus package to maintain growth at a time when its revenues from sources such as the Suez Canal, exports, tourism and foreign direct investments (FDI) were dropping. Not only that, but income, sales tax and customs proceeds also dropped on the back of slower growth. "Businesses were affected, they made lower profits and thus paid less taxes," El-Fiki said. The drop in FDI from $13 million in 2007/08 to $8 million in 2008/09 also meant less new projects or expansion taking place, thus affecting the import of capital goods and, accordingly, customs. Capital goods represent 39 per cent of non-petroleum imports. According to recent Central Bank of Egypt figures, imports dropped by 17.2 per cent in the second quarter of 2009/10 compared to the same in the previous year. In event of a lack of sufficient revenue the government has made ends meet by borrowing from the local market. Domestic debt, according to El-Fiki, stands at 65 per cent of GDP while international debt stands at 15 per cent of GDP. That makes total government debt around 80 per cent of GDP. "The ideal, according to international standards, is 60 per cent of GDP," said El-Fiki. Nonetheless, "while the large government borrowing requirement represents a potential risk, financing should be available without undue stress," said the IMF in a recent report summarising the findings of its Article IV regarding consultations with the Egyptian government. It added: "the authorities could also consider diversifying towards additional foreign financing. These steps can help lengthen the average maturity of the debt, reduce financing costs, and lessen pressures on the banking system to finance the budget." While Doha Abdelhamid, professor of finance at the American University in Cairo, acknowledges that foreign borrowing would help diversify Egypt's debt portfolio, domestic borrowing remains more attractive, she said. She pointed out that the government is borrowing from a vast pool of underutilised deposits in the banking sector. Loans account for only around 54 per cent of deposits in Egypt. Furthermore, at today's interest rates, the cost of funding is very low and the funds are easily accessible. In the meantime, she said, while borrowing from abroad today may be cheap, because interest rates are low, it will not remain so for long. "When the global economy shapes up, interest rates will rise gradually." She added that the process of underwriting foreign debt is very costly and time consuming. Egypt is reluctant to take on foreign borrowing for other reasons as well. Just prior to the first Gulf War, says El-Fiki, Egypt's foreign debt had amounted to 120 per cent of its GDP. "Were it not for the debt forgiveness and reduction that followed the war, Egypt would have been in deep waters," he said. With all these factors in mind reducing the budget deficit appears a daunting task. But according to the IMF, it is doable: "reducing the overall deficit by about five per cent of GDP over the next five years is feasible, based on the experience of other countries, and would lead to a further 15 percentage point decline in the debt-to-GDP ratio. Such adjustment will be crucial to maintain investor confidence, preserve macroeconomic stability, and create scope for future countercyclical fiscal policy." The reduction in the budget deficit, according to El-Fiki, will come on the back of increased growth as well as the targeting of new sources of income. He pointed out that hope is pinned on the full-fledged application of the property tax on some 30 million units across the country. "In the long run it could bring in at least LE10 billion in annual proceeds," he said, adding that it is targeted to bring in LE2 billion in the 2010/11 budget. The IMF acknowledges that some difficulties lie ahead, but is confident that: "While adopting major reforms could be challenging with the approaching elections -- as evidenced by the delays in the property tax -- the mission encourages the authorities to continue taking measures such as strengthening tax compliance." Another source of income, according to the IMF, is "adopting as early as possible a full- fledged [value added tax]." Abdelhamid explained that a value added tax would take the sales tax, currently applied, to a higher stage. Rather than taxes being paid at the end of the production process, by the consumer, taxes would be collected at every stage of production, she explained. But while this would definitely boost government revenues, "it would cause prices to skyrocket and deal an aggressive blow to the Egyptian citizen whose income cannot take additional expenses." Besides looking for additional sources of income, the government has also got to watch spending. El-Fiki pointed out that the subsidy bill greatly benefited from the drop in international prices of oil and food products, but "an improved global economy will mean that prices will escalate again." To deal with that, "subsidies need to be better targeted and should take the form of direct money assistance." Abdelhamid wants to see a proper targeting of subsidies as well. "Despite continued announcements by the government that it would revisit and rationalise the subsidy system, neither the strategy nor the tools that would make it happen have yet been announced." As the IMF put it, the government needs to reduce "the cost of subsidy abuse, and also to resist pressures for additional spending." But Abdelhamid warns that despite the widening deficit the government should not abandon its stimulus for the economy. She disagrees with the IMF that, "the need for further stimulus is waning." She pointed out that so far the stimulus has been directed at infrastructure projects. She wants funds to be directed at setting up productive projects that create jobs.