After several years marked by turbulence and uncertainty, Egypt's economy encountered numerous challenges, from political unrest and declining tourism, to foreign currency and fuel shortages, which led the government to adopt an economic reform programme to improve Egypt's public finances. Between September and November 2016, authorities introduced the value-added tax law (VAT), a free-floating currency, raised the price of subsidised fuel, and went on a borrowing spree from the International Monetary Fund (IMF), the World Bank, China, and others to finance its ambitious programme. The road to the economic reform programme Egypt's economy had been suffering after going through a revolution in 2011, due to political instability in addition to regional and local security risks, which had a negative effect, especially on the tourism sector. These factors escalated Egypt's already existing structural problems which can be pinpointed in three main challenges, according to the IMF. First, the foreign currency exchange rates and reserves. The Central Bank of Egypt's (CBE) policy of preserving the Egyptian pound exchange rate against the US dollar had a very negative impact on the economy, leading to lower external competitiveness, drainage of foreign reserves—dropping to $19bn in October 2016—and a foreign exchange crisis. Second, the extremely high budget deficit and public debt due to weak revenues, tremendous subsidy bills that are mismanaged and not reaching eligible recipients, combined with an overgrown public sector wages bill. These resulted in a deficit and debt values that exceed Egypt's total GDP. Finally, low growth rates achieved after the 25 January Revolution, resulting from structural issues which have constrained growth and job creation, in addition to diminished tourism following the crash of a Russian aeroplane by Islamic State in October 2015. The government's reform plan According to the IMF, Moody's, and the World Bank, the government's main focus should be on reducing the high fiscal deficits through significant monetary and financial policy changes, such as adopting a more flexible exchange rate, introducing the VAT, removing fuel subsides, and containing inflation, which in turn will encourage investments and exports. Yet, they all advised the Egyptian government to improve its social safety net to shield the poor and the vulnerable from the negative consequences of the reforms. The social protection measures that need to be put in place can be summarised into three main points, according to mission chief for Egypt and advisor to the International Monetary Fund's (IMF) Middle East and Central Asia Department Chris Jarvis. Firstly, increasing food subsidies by raising the value of the subsidy offered through food smart cards from EGP 15 to EGP 21 per person. Secondly, expanding the takaful and karama programme to reach 1.7 million households and 7.3 million beneficiaries, in addition to expanding the social pension budget to reach another 1.7 million households, and the general pension as well. Finally, smaller programmes targeted to specific vulnerable groups, such as more free school meals and new gas connections for poor districts. The government should increase subsidies for baby formula and children's medicines, and will preserve or increase vocational training for young people On 3 November, the Central Bank of Egypt (CBE) decided to adopt a flexible exchange rate regime, in a move aiming to increase Egypt's external competitiveness, rebuild its foreign exchange reserves, support exports and tourism, and attract foreign investment. On the same day, the government took the decision to decrease fuel subsidies. The effects of the liberalisation of the Egyptian pound and the scrapping of fuel subsidies continue to be felt in the economy. The pound has lost more than half its value since then, which had a great impact on the costs of production as well as the cost of living. December's negative Purchasing Managers' Index (PMI) rate and multi-year high inflation in November both confirm the adverse effects of a heavily weakened currency on net importing countries. Yet, the government continues to push reform programme policies forward, aiming to encourage investment and reviving the economy, which only managed to grow a mediocre 4.3% in fiscal year (FY) 2015/2016. The new policies include removing profit repatriation restrictions and approving Egypt's first bankruptcy law. The floating of the pound and structural reforms, although harmful in the short-term to producers and consumers, will gradually yield results, particularly in terms of increased inflows of US dollars and foreign direct investments (FDI) into the economy, as well as improved fiscal governance, according to FocusEconomics' January report. The same report mentions that the GDP is expected to expand 3.4% in FY 2017. The panel sees growth of 3.8% in FY 2018. Headline inflation came in at 23.3% in December, marking a 3.9% increase from November. The report forecast inflation to average 18.9% in calendar year 2017and 14.6% in calendar year 2018. At the same time, Moody's credit ratings outlook for January 2017 concluded that despite a series of negative shocks, it believes that Egypt retains the region's highest economic strength assessment, which reflects not only its scale but also its growth outlook compared to peers. They forecast that the economy will grow by 4% and 4.5% in 2017/2018, supported largely by private consumption, as well as increasing public and private investment. The impact of the economic reform programme on different sectors For the real sector, short-term effects of floating the pound took its toll on Egypt's business conditions. Although the flotation is expected to eventually help the ailing economy, the near-term ramifications of the weakening of the currency against the US dollar are still being felt. Sky-high inflation levels played a key role in the poor performance of operating conditions in Egypt's private sector. Against the backdrop of a weakening Egyptian pound, the recently introduced VAT and higher oil prices, the costs of raw materials continued to rise, becoming more and more unaffordable and in short supply, as mentioned in the Emirates NBD PMI index. "If there is a silver lining to be found in this latest report, it is that new export orders decreased at the slowest pace since September 2015. Although the process will not be immediate, a weaker Egyptian pound following November's devaluation will eventually help boost export growth, which will clearly be welcome as the rest of December's survey continues to point to weak domestic demand," Jean-Paul Pigat, senior economist at Emirates NBD, said. The government targets growth of 5.2% in FY 2017 and 5% in FY 2018, according to the reform programme plan. Yet, FocusEconomics forecast the economy to expand by 3.4% in FY 2016/2017 and by 3.8% in FY 2017/2018. On the other hand, the World Bank expected growth rates of 4%, and 4.7% for FY 2016/2017 and FY 2017/2018, respectively. For Egypt's monetary sector, inflation continues to surge to an over eight-year high in December. Consumer prices rose around 3.1% in December compared to November. However, the increase was below the 4.9% expansion seen in November. According to FocusEconomics, the flotation of the Egyptian pound and the hike in regulated prices of subsidised fuel has led to a build-up of inflationary pressures. According to the Central Agency for Public Mobilization and Statistics (CAPMAS), higher prices were seen across all subcomponents, with those for food, beverages, and transportation having the biggest impact on the index. According to the IMF and the World Bank, the CBE must navigate the recent move to a more liberal exchange rate regime. Gradually reducing inflation is a priority, including ensuring that the new VAT results in only a one-time increase in inflation, rather than an ongoing spiral, by maintaining adequately tight monetary policy to contain secondary pressures and reduce inflation to single digits in the next three years. Inflation reached 23.3% in December. The reading was well above November's 19.4% and the highest reading since August 2008. Since the pound was floated, the value of the pound against the dollar has been reduced by more than 50%, which in turn led to a dramatic increase in the prices for imported goods and internationally-priced local commodities, coupled with the downsizing of fuel subsidies and VAT implementation. This greatly reduced the Egyptians' purchasing powers , according to FocusEconomics. Regarding price developments, the CBE noted that November's headline inflation reading was largely impacted by IMF-backed economic measures, including both the exchange rate liberalisation and the scrapping of hydrocarbon subsidies. The free-floating of the Egyptian pound in early November caused consumer prices to spike in the same month, which could call for further hikes. The CBE reaffirmed its commitment to a price stability mandate and said that it will closely follow the impact of economic and monetary developments on the inflation outlook. The CBE's next monetary policy meeting is scheduled for 16 February. Furthermore, the CBE has decided to maintain all interest rates unchanged at their respective multi-year highs. The overnight deposit rate currently sits at 14.75%, while the overnight lending rate at 15.75% and the main operation rate at 15.25%. In 2016 overall, the bank hiked interest rates by a cumulative 550 basis points as the country struggled against a widening disparity between official and unofficial exchange rates. Consequently, Moody's expects that the socioeconomic discontent in Egypt, fueled by the high inflation and the reduced purchasing power, could result in growing anti-government sentiment in 2017/2018. Although the army has been relatively successful in neutralising opposition, security risks persist, as evidenced by scattered terrorist attacks targeting security forces and government officials, as well as civilians. In conclusion, the success of the Egyptian economic reform programme supported by the IMF is conditional on a continued stabilisation in the security environment, boosting investments by infrastructure projects, and the renewed development of natural resources. In their January reports, Moody's and the IMF expected that the investment incentives from the recent devaluation of the Egyptian pound, the adoption of a flexible exchange rate system, and the revival of the tourism sector to its previous levels may outweigh the short-term challenges stemming from higher inflation and reduced purchasing power for domestic consumers.
