For the first time since 1999, the International Monetary Fund has issued an encouraging report on the Egyptian economy. Yasser Sobhi sifts through the signals that have improved prospects for higher rates of growth in the coming year The Egyptian economy is to grow by nearly four per cent in fiscal year 2002/03, up from two per cent last year, new International Monetary Fund estimates have predicted. A rise in non-oil exports and tourism receipts, in addition to a revival in consumer confidence, have been sufficient indicators for the IMF to issue the highest growth estimates for the Egyptian economy since 1999, at a time when its forecasts for global economic growth, and for the US economy in particular, remain modest. "With appropriate macroeconomic policies and a continued recovery of confidence, we see prospects of a recovery in growth to the 3.5- 4 per cent range in 2002/03," states the concluding report of the 2002 Article IV consultation discussions with Egypt, issued by the IMF at the end of their mission in July. Pointing out that the key challenge for the coming year is to nurture Egypt's "nascent" economic recovery, the report maintains that the external environment is unlikely to provide a major push, with global growth probably remaining modest, which will affect foreign direct investments and other capital flows to Egypt. "However, advance tourism bookings are favourable, commodity exports are growing, the energy sector is attracting increasing investment and a tentative recovery in domestic confidence should strengthen and underpin somewhat stronger growth in consumer spending and a recovery in private capital spending," the report said. Last year was a difficult one for the Egyptian economy. At a time when a recovery in growth had been in prospect, the economy was hard hit by the events of 11 September. A sharp fall in tourism and deteriorating global economic conditions both weakened the domestic economy and put pressure on the balance of payments, the report said, creating a particularly difficult environment for conducting macroeconomic policy. However, the IMF seems to think that the economy weathered the downturn relatively well. After tourism revenues were slashed in half, there was a faster-than-expected recovery, and, by June 2002, the number of tourists flocking into the country was almost back at its pre-11 September level. The IMF anticipates a manageable balance of payments position in the new fiscal year. A significant recovery in imports is likely, reflecting rising demand as growth picks up and foreign currency liquidity improves. But this would be offset, in large part, by rising non-oil exports and higher tourism incomes. In fact, the external sector shortfalls were smaller than projected earlier by the IMF -- the overall balance of payments recorded a deficit of less than one per cent of GDP in 2001/02, considerably below the IMF projection following 11 September. The report sees it as a reflection of the authorities' decision to limit intervention in the foreign exchange market. Furthermore, due to a decline in non- oil imports combined with a stronger-than-expected tourism outcome, the current account showed only a small deficit of some $200 million in the fiscal year just ended, compared to the IMF estimation in January of a deficit of $2 billion. The outlook for the Egyptian economy is, nevertheless, not all rosy. The exchange rate market remains a major challenge. The report pointed out that the functioning of the foreign exchange market has improved following the depreciation and reforms of the adjustable currency band system in August 2001, followed by a further depreciation of the band in December. But, "a large, more depreciated parallel currency market emerged outside the band. Although the rate in the parallel market has appreciated in recent months, narrowing the spread relative to the rate in the official market, there is still effectively a dual exchange rate system". IMF experts insist the government must put a stop to this dual system and the parallel market's illegal transactions. Still, the IMF sees a brighter side to the recent currency devaluation. Between mid-2000 and early 2002, the Egyptian pound has witnessed a depreciation of 35 per cent against the dollar. The subsequent depreciation of the US dollar (together with the EGP) against the euro and other currencies has caused the real effective exchange rate to depreciate by about 25 per cent through June 2002. "The flexibility of the exchange system since mid-2000 has strengthened competitiveness. This improvement in competitiveness has already been reflected in the strengthening of the trade account. It is also a likely factor behind the recovery that now appears to be underway, although the beneficial effects have probably been damped by the recent shortages of foreign currency in the official markets." The report went on to say that the IMF shares the authorities' view that Egypt is presently best served by a flexible exchange rate. "Some progress toward this goal has been made over the past two years, though further improvements are needed. In our view, the key goal is to ensure the early establishment of a unified and liquid exchange market in which the rate is responsive to market conditions," the report said. Unfortunately, since Egypt has used its fiscal policy instruments almost to the full, the scope for further macroeconomic stimulus is limited. The IMF estimates a slight decline in fiscal deficit for the coming year to five per cent of GDP, down from 5.8 per cent and 5.5 per cent in the last two years. While this deficit level is generally considered manageable, a rise beyond it would be difficult to accommodate. "There is now little or no further scope for an easing of fiscal policy to promote economic growth -- a view we believe is shared by the authorities," the report said. Meanwhile, the IMF views the country's monetary policy as appropriate. It shares the Central Bank of Egypt's (CBE) view that broad money growth of about 9.5 per cent is a reasonable target for the coming year, which would provide scope for an increase in private sector credit of nearly 8.5 per cent. IMF representatives discussed with the authorities a monetary scenario designed to support economic recovery while maintaining Egypt's record of low inflation. Although the report predicted a slight increase in the inflation rate to 3.5 per cent from 2.8 per cent and 2.2 per cent in the two previous years, the figure is lower than expected in view of the significant devaluation of the Egyptian pound. There is a need for greater interest rate flexibility throughout the financial system, the report opined, to accelerate the development of CBE policy instruments, policy-making infrastructure and operational tools to strengthen liquidity management. Further structural reforms were also strongly urged. While the IMF's annual report praised the last two years' reforms, particularly those in the banking and trade sectors, more was expected. Egypt should accelerate its privatisation process, further liberalise its multilateral trade ahead of the association agreement with the European Union, reduce the number of tariff rates and improve customs administration, improve the macroeconomic database and transparency issues and upgrade its pension system and tax administration. As for the financial sector, the report said considerable progress has been made in recent years in developing the supervisory and regulatory framework. Improving access to credit, enforcement of creditors' rights by strengthening the functioning of the legal and judicial systems and credit information are among the planned reforms. Large public sector banks, which are the heart of the system, need to improve yields, strengthen management systems and increase their staff efficiency. "We fully agree with the authorities that the main objective over the medium term is to create adequate employment opportunities for Egypt's rapidly rising labour force, as well as raising living standards. This will require sustained high economic growth, which should be led by the private sector, with exports playing a more prominent role," the report said. The IMF's positive analysis of the performance of the Egyptian economy could mark a turning point in a drawn out recession caused by conservative policies. But, in order to regain consumer and investor confidence, it will take more than an optimistic report. The credibility of the Egyptian economy and its policy-makers will only be proven with more substantial, faster- paced reforms that deliver concrete results.
