Since February 2011, Egyptian authorities have designed their fiscal, monetary and exchange rate policies for the sole purpose of preventing the gradual rise of prices for the broad base of Egyptians, in particular, the urban poor and the lower-middle classes. Their bet was on the quick re-establishment of a functional political system via free elections and a ratified Constitution — part of which they failed to deliver on. Their tool was the continued dependence on decreasing foreign reserves to sustain the same levels of consumption through the transitional period. However, the quick and un-orchestrated devaluation of the Egyptian pound together with the doubling of inflation rates over the last month are proof that this policy is no longer sustainable. The Egyptian economy was not allowed to gradually deteriorate in the last two years of political turmoil and economic contraction, and thus it is rather likely that it will witness a sudden economic crash, and possibly a political one as well, in the immediate future. According to the Central Bank of Egypt, the inflation rate increased over the last month from 5.23 to 7.68 percent. This is considered to be the highest increase in more than a year. One has to bear in mind that Central Bank estimates are usually quite conservative, which implies that the actual inflation rate is considerably higher than the official one. Meanwhile, foreign reserves shrank to about US$13 billion, despite a $5 billion transfer from Qatar in January. Overall, no sign of economic recovery seems credible as social and political turmoil ensues unceasingly. The International Monetary Fund agreement is far from being completed, as the government looks hesitant to commit to any serious austerity measures. It seems that Egypt has passed the phase of economic crisis into that of an economic crash. The crash here refers to the probable disruption in price signals mainly through soaring product prices (inflation), rising interest rates and the plummeting of the Egyptian pound versus the dollar and the euro. As said before, fiscal, monetary and exchange rate policies since Hosni Mubarak's ouster have been managed in such a way as to prevent a gradual deterioration in the economic situation for the broad base of Egyptians. In this context, foreign reserves were used to uphold the Egyptian pound and avoid any gradual devaluation. However, the subsequent devaluation despite these measures may actually have caused a considerable increase in the inflation rate and prices of basic products, especially since Egypt is a net-food and oil importer. Politically, the formerly ruling military council found the transitional period too risky to tackle the budget deficit. The 2012 and 2013 budgets that were issued and ratified by the military council sustained the same expansive subsidy programs, allowing the deficit to expand to about 10 percent of the gross domestic product. Reserves were enough to sustain the pound, finance basic imports and service the debt. But a little over a year ago, the military council started to count on different forms of foreign borrowing to support the reserves and finance the budget deficit. The main forms of foreign credit were either deposits at the Central Bank or foreign loans directly channeled to economic authorities, such as the Egyptian General Petroleum Corporation and the Supplies Authority. Either way, the mounting foreign debt did not appear on the Egyptian foreign debt stock because it was either counted as a liability against the Central Bank or economic authorities versus the central government. Yet the treasury will be the party paying this newly incurred debt. What is more problematic is that this credit, which is estimated at $10 billion, was primarily used to finance recurrent expenses. What was the rationale behind this policy? Authorities inherited an ever-widening deficit from Mubarak's time. The budget structure is quite inflexible with three quarters of it made up of subsidies, wages and debt service. Moreover, the shaky political situation after the revolution ruled out any serious attempt to undergo fiscal restructuring or to apply austerity measures. This is attested to by the inconclusiveness of successive negotiation rounds with the IMF since February last year. The election of Mohamed Morsy as president in July did not change things much, as political stability remains far from reach. Given the economic and political inflexibilities of successive post-Mubarak successive regimes, the only viable option was to keep things as they were, hoping that political stabilization would lead to some economic recovery and thus allow the rebuilding of the reserves, which never took place. The only option the government has is to keep borrowing from abroad on a short-term basis to avoid a sharp devaluation of the pound and thus the explosion of inflation rates, combined with severe fuel shortages in many provinces. However, such a solution is myopic, short sighted and unsustainable as buying time in this context will only mean a severer crisis in the future. Amr Adly is a postdoctoral research fellow at the Social Sciences Cluster at Stanford University in the US. This piece was originally published in Egypt Independent's weekly print edition.
