Reform of Egypt's expensive fuel subsidy is likely to be gradual despite the government's recently repeated intention to address the problem, says Fitch Ratings. Fuel subsidies account for about 20% of government spending and 73% of all subsidies. Successful reform of these subsidies is the single-biggest reform the government can make to improve Egypt's fiscal position or free up revenue to spend elsewhere. We believe significant cuts will be difficult to agree this year and may have to await next year's budget, which starts in July. But the government may decide to make smaller reductions before the end of the year in order to start the process and signal its intent, especially in the context of IMF negotiations. Cutting fuel subsidies has been on the Ministry of Finance wish list for years. However, political resolve to address the issue seems greater since the fall of the Mubarak regime. As early as June 2011 the IMF acknowledged agreement on the need to cut the highly inequitable and costly system of subsidies' but said this would not start before a social safety net had been put in place. The success the government has had with better targeting subsidies shows that it is now possible to distribute them more effectively. Wider use of coupon or smart card systems could be a compromise to reduce the overall cost while limiting the social impact. This could reduce the chance of wide spread social unrest, as was seen in Nigeria earlier this year when leaders attempted to scrap its fuel subsidy overnight. However, the subsidy's entrenchment means the government will find removing it quickly or entirely will be difficult, notwithstanding political desire and likely IMF pressure. Prime Minister Hisham Kandil acknowledged this in a recent Financial Times interview when he stated that the aim is to save EGP40bn (USD6.56bn) this financial year, but that the most important thing is to start. If the government does begin cutting the subsidy and publishes a timetable for its eventual removal - probably a minimum IMF demand - then we would expect funds from the IMF and other donor organisations to provide Egypt with breathing space.
