Fitch upgraded its rating on the Government of Egypt by one notch to B+ on 21 March, one notch higher than S&P and two higher than Moody's.
Egypt's IMF Deal: What Chance of Success?
On 11 August, Egypt and the IMF signed a staff level agreement under which the IMF will lend Egypt $12 billion over three years.
The agreement has been seen as a significant achievement for the Egyptian government, removing the threat of a budgetary and foreign exchange crisis, committing Egypt to a programme of economic and fiscal reforms, and opening the way for additional financial aid from other sources.
The Arab Bankers Association spoke to Hugh Miles the co-founder of the Cairo-based Al Shafie Miles business intelligence consultancy, about the terms of the IMF agreement and how it is being received in Egypt
Arab Bankers Association: What are the main points of the agreement?
Hugh Miles: The IMF will lend Egypt $12 billion over three years, subject to certain conditions.
The programme's explicit aims are to improve the functioning of foreign exchange markets, reduce the budget deficit and increase economic growth.
More specifically, in order to keep the programme on track (and the disbursements flowing), Egypt will have to continue to reduce energy subsidies (ie, further increase the price people pay for electricity), implement the VAT law (under which VAT will replace the current 'sales tax' initially at 13% and then at 14%), and move to a flexible exchange rate policy (which means that the pound, which was devalued by 14% in March, will have to be devalued again.)
Looking at monetary policy more broadly, there are three objectives - improvement of foreign exchange markets, increasing foreign reserves and reducing inflation to below 10%. Inflation accelerated to 15.5% in August, the highest rate since 2008 and analysts are predicting it will hit 20% by the end of the year.
The IMF press release announcing the staff-level agreement also refers to policies geared towards 'safeguarding the strength and stability of the banking system.’
Both the IMF and the Egyptian government have stressed that social protection would be an important part of the programme. Savings in some areas will be used to increase spending in others, such as food subsidies and 'targeted social transfers'.
Nonetheless, if Egypt is going to keep the agreement on track, it will have to continue cutting subsidies, reduce the size of the public sector, and reduce the bureaucratic hurdles to foreign investment. These are all difficult things to do. They have been tried in the past and have not always been successful and, in some cases, these measures could lead to social unrest. The current situation is similar to that in January 1977 when the rise in the price of basic commodities lead to bread riots.
But, if the agreement goes according to plan, the government’s budget deficit will narrow, investment in areas such as education and health will increase, jobs will be created, and the pain associated with currency devaluation will be muted.
Successful implementation will also enable Egypt to seek loans from bilateral donors and will improve its ability to raise commercial funds on the international bond market.
Remember that what happened in August was a ‘staff level’ agreement, meaning that it is the deal agreed between Egyptian officials and IMF staff at the end of the staff visit in early August. To take effect, the agreement needs to be approved by the IMF’s Executive Board which is expected by 9 October.
One precondition for Board agreement is that Egypt had to find $6bn in additional funding to complement the IMF’s $12 billion. The Egyptian government has said an agreement has already been reached with Saudi Arabia for part of this and Egyptian media reported that deposit from the Kingdom was expected at the Central Bank at the end of September. Saudi Arabia and the UAE have already given President Sisi’s government billions of dollars since he came to power in 2013.
Why is the introduction of VAT deemed so important when Egypt already has a sales tax?
VAT is regarded as preferable to the sales tax because, as a general tax imposed on both imports and domestically produced goods, VAT is less distortionary than a sales tax and less of a burden on consumers. VAT is also expected to help Egypt construct a more efficient tax administration and lessen tax evasion.
VAT is seen as one of the riskiest elements of the IMF plan as it is likely to lead to an increase in inflation which could in turn trigger further social unrest in a country where millions already live in poverty. The Egyptian government is taking steps to help the most needy by increasing the number of beneficiaries in its cash transfer programme to 1.5mn families from around 700,000 currently.
If VAT is successfully implemented it will be a major achievement and it will help solve one of Egypt’s longstanding economic problems: what to do about the shadow economy, which constitutes between 40%-60% of the total economy. VAT should help put much of this economy under state control for the first time.
Notably the Egyptian armed forces, who control a significant part of the economy and constitute Sisi’s core constituency, will be among those exempt from VAT.
What has the Parliament already approved by way of financial reforms?
The Egyptian parliament passed its economic reform programme in July 2014. Since then the main development has been the introduction of new taxes and a reduction in subsidies, starting with gasoline and, more recently, electricity. In August, the government announced that electricity prices were being raised retro-actively by 25 to 40 per cent, depending on consumption levels.
The regime has also made a number of other important economic changes, such as passing a new investment law and allowing the private sector to import natural gas.
After months of debate, parliament finally passed the long-delayed VAT law on 29 August, President Sisi ratified it on 7 September and the Ministry of Finance was due to issue bylaws for the new legislation within 30 days. The current sales tax will stay in place until these are published in the official gazette. All bureaucratic mechanisms are supposedly in place to start collecting VAT imminently.
How is the IMF agreement being seen in Egypt?
Egypt and the IMF have a difficult history so there is considerable suspicion about this loan among many Egyptians and in the national media.
Twice before, in the Mubarak era, Egypt had staff level IMF agreements to borrow money but they ultimately failed to materialise.
This time around the fact the government has already started a programme of cutting subsidies is being taken as proof that the Sisi government is more serious about reform and implementing an IMF deal.
Nevertheless many people think the IMF plan is simply not workable, or that it is not going to be large enough to make a difference to the economy given its size and the extent of the challenges that it is facing.
Many political parties, NGOs and public figures have spoken out against the IMF agreement. A loose coalition of concerned public figures recently wrote an open letter to President Sisi warning against it and calling on him to suspend all dealings with the IMF at once. The Muslim Brotherhood, which remains a banned terrorist organisation, also opposes the deal.
In contrast, the business community has welcomed the agreement. It sees no alternatives to the IMF plan, which is considers to be an act of national salvation. The business community is hoping that this agreement will move forward, unlike the two that failed in the past.
In my view, a plausible scenario is that the IMF deal will be approved, will move forward well in its early stages but will then falter as Egypt fails to deliver on the reform programme. When President Sisi judges that continuing reforms has become too costly in terms of popular support, Egypt will fail to meet its obligations or just abandon the deal altogether. This would put the IMF in the difficult position of having to put pressure on Egypt - and so risk another popular uprising or driving Egypt into the arms of a strategic rival such as Russia or China, an outcome the IMF is trying to avoid - or backing down. If the IMF backs down then the Egyptian economy will still not be fixed, just slightly better placed to continue for a few more years before another financial crisis ensues and the IMF merry-go-round starts all over again.
Hugh Miles is an award-winning investigative journalist specialising in the Middle East and North Africa. He has worked for a wide variety of media, including the BBC, CNN, the Guardian, the Daily Telegraph, the London Review of Books and many more. He is the author of two books, Al Jazeera: How Arab TV News Challenged the World and Playing Cards in Cairo. He lives in Cairo.
Al Shafie Miles is a Cairo-based business intelligence consulting specializing in the Middle East and North Africa. It has particularly strong contacts among the Middle East diplomatic community, both local and foreign. In addition to a specialist newsletter about Saudi Arabia, Al Shafie Miles also manages Arab Digest, a private members club made up of a few hundred elite people worldwide. For a one month free trial of Arab Digest’s daily newsletter please visit https://arabdigest.org/visitors/free-30-day-trial/
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