Dr. Ahmed Galal, Egypt's Minister of Finance, stated that government targets to push GDP growth between 3-3.5% in FY2013/14, up from 2.2% in FY2012/13 (vs. EFG forecast: 3.0%), mainly through fiscal and monetary stimulus and counting on a recovery in tourism as security is restored. He added, in a conference call held by EFG-Hermes on 23 September that such acceleration will not, however, result in major inflationary pressures, given "the slack of the economy"; hence, the minister sees inflation stable towards the 10%-mark (EFG forecast: 9.4%). The minister targets narrowing the fiscal deficit to 10% of GDP in FY2013/14 from c14% in FY2012/13 (EFG forecast 13.4%), mainly relying on the GCC aid benefits of lower borrowing costs and a reduced subsidy bill. The narrower deficit will also be the result of planned fiscal reforms, mainly rationalising fuel subsidies. The current interim government views the transition period as foundational, with its role focusing on steering the economy towards a clear path of recovery and preparing it for take-off by the time an elected government assumes office some time by mid-2014. To that end, the government is adopting a proactive approach in dealing with Egypt's economic problems. The government aims to stimulate economic growth by utilising the external support from the GCC countries, as well as undertaking necessary reforms to put Egypt's economy on a sustainable path. To that end, the government announced a USD3.1 billion fiscal stimulus, which was also complemented with monetary easing by the central bank. In parallel, the government is preparing a number of reform initiatives, mainly targeting fuel subsidy rationalisation and the introduction of the long-awaited value-added tax (VAT). The minister highlighted the government's focus on policy measures to respond to rising social demands since the 25 January revolution. Increasing public minimum wages was one major move in that direction. Other steps to follow include increasing spending on health and improving social services. Long-term plans are being studied, including a cash transfer programme and measures to incorporate the informal sector into the formal economy. The minister outlined the government's economic statement of purpose, namely that Egypt is currently going through a foundational phase where the government sees its role as steering the economy towards a clear path to recovery and paving the way for the next elected government to accelerate growth. In that respect, the current government is adopting a proactive approach in fixing the economy's woes, executing much-needed structural reforms. The government's economic policy is focusing on two main areas: i) reversing a weak macroeconomic backdrop it inherited; and ii) appealing to social demands which have been ignored for long. To that end, the government is focusing on utilising the GCC support to jumpstart the economy and balance the weaker tourism sector. It announced a USD3.1 billion stimulus package, mainly focusing on infrastructure spending. This was also supplemented by the Central Bank of Egypt's push for monetary easing to support growth. The CBE reduced policy rates twice by 50 basis points each over the past two months, supporting a rally in the fixed income market where yields on T-bills fell by c300 bps. The minister highlighted that the government is looking to supplement the fiscal and monetary impulse by implementing economic reforms to further put Egypt's economy on a sustainable path. To that end, the government is looking to introduce the first phase of fuel subsidy reform within the next two months. This phase will mainly consist of distributing smart cards for owners of vehicles which consume diesel and gasoline. The aim is to reduce subsidy waste/leakages without rationing quantities or increasing prices, which will come at a later stage after the existing government, would have left office. The minister estimates the government could save up to EGP20 billion (1.05% of GDP) in the first stage of the fuel subsidy reform. In parallel, the minister added that other reforms include the implementation of the property tax. He also stressed he is working hard to implement the value-added tax (VAT) before leaving office some time mid-2014. The government will, however, refrain from increasing taxes as it does not consider this the right time to add a burden on investors. On the IMF, the minister said it remains an option on the table though not in the short term. The government believes it currently does not the funding or the accreditation of the IMF as it is receiving sizeable support from the Gulf countries and at even more favourable terms. Commenting on the difficulties facing equity investors in repatriating their profits, the minister expected the problem to ease as foreign exchange liquidity continues to improve. The government is also working on supplementing these macro policy moves/decisions with a focus on responding to the rising social needs of the population. The highlight was the announcement last week of a minimum wage for the public sector amounting to EGP1,200 (USD171) per month. The minister said the government is currently working on calculating the cost of such measure. We note the minister adjusted his fiscal deficit forecast to 10% from an earlier 9% following the announcement. Responding to a question on the impact of such a hike in wages on the economy's competitiveness, the minister said this decision only affects the public sector. Negotiations on a minimum wage for the private sector are still ongoing and he trusts all the engaged parties will reach an agreement that does not impact the industrial sector negatively. Further on the social measures, the minister added the government is focusing on improving social services; the ministry is working on a revised budget to increase spending on health. Other long-term strategies include the implementation of a conditional cash transfer programme that is currently being studied by the Ministry of Social Solidarity. Such programme will involve a major shift in subsidy strategy where the government targets people rather than commodities, but one that is likely to require some time before being implemented. The minister also discussed plans the government is considering for absorbing Egypt's large informal sector into the mainstream economy. He estimated the informal economy represent c30% of GDP and employs c40% of the labour force. We see the government's target of narrowing the budget deficit to 10% of GDP as being a challenging one. Indeed, the budget will benefit from lower borrowing costs and cheap energy supplies from the Gulf, but we are sceptical about the ability of the planned reforms, namely fuel subsidies and VAT, to realise major savings in a short period of time. These reforms involve various time-consuming administrative measures, which will not allow the budget to benefit in full in this fiscal year, especially that a quarter of the year has already passed. We, therefore, reiterate our view that the smart card system can reduce the fuel subsidy bill by 10% (EGP12 billion) at best in its first year of implementation. Moreover, the suggested timeframe for the introduction of the VAT suggests FY2013/14 will not benefit from increased revenues of the tax. We, therefore, maintain our expectation of the deficit remaining stable at 13.4% of GDP in FY2013/14. The implementation of the recently announced minimum wage for the public sector is likely to pose downside risks to the budget deficit. As for growth forecast, we share the minister's view of growth accelerating from Fy2012/13 levels though our forecast of 3.0% in FY2013/14 is at the lower band of the minister's forecast band of 3.0-3.5%. We see growth remaining driven primarily by private consumption as remittances and rising wages support increased consumer spending, while investment, most notably private investment, remains weak. The fiscal stimulus will support growth to a small extent, but the economy will continue to feel the pain of depressed levels of tourism and capital inflows. Inflationary pressures remain indeed weak, given a slack economy, but we see them stabilizing at this stage before possibly increasing in early 2014 as the government implements the minimum wage. The latter will witness a substantial increase in the wages of those earning less than EGP1,200, resulting in a classic inflationary effect of increased wages with stable productivity. In a broader sense, however, the move highlights the challenges facing policy makers over the coming few years in balancing rising social demands after the revolution with sustainable macroeconomic trends. The need to increase spending on social services, implement a nationwide health insurance system and overhauling the pension system are just a few items on the list, highlighting the difficult balances the economy has to strike over the coming years.
