Egypt: Bread, Freedom, and the IMF
Bread and freedom was the protest call of Egypt’s Arab Spring in 2011. Five years later, precious little of either is available. The Sisi government’s funder, Saudi Arabia, has deserted Egypt over a territorial dispute, disagreements in the UN security council, and its own fiscal woes. With nowhere left to turn, Egypt has at long last negotiated a $12 billion loan from the International Monetary Fund (IMF). Following the IMF plan, other lenders are anticipated to bring in another $6 billion.
Going to the IMF is a necessary condition to get the country back on a growth path, but there is reason to doubt whether it will be sufficient. Egypt waited so long to undertake economic reforms that now the required adjustments are large and the global demand is weak. And after years of slow growth and high unemployment, the Egyptian people are exhausted.
Egypt waited so long to undertake economic reforms that now the required adjustments are large and the global demand is weak.
The pre–Arab spring social contract included government jobs and cheap consumption via subsidies and strong currencies in exchange for stability and limited political freedom. As the working population grew, the economic part of the bargain became unsustainable. With little in return, the political part became unacceptable, leading to the call for bread and freedom.
In 2011, shortly after Mubarak fell, the IMF outlined a $3 billion support package for Egypt. That package would have come with no strings attached and aimed to support social justice and assist in the transformation of the Middle East.
IMF offerings were rejected first because the transitional government claimed no authority to negotiate, later because money flowed to the Morsy government from Qatar and Turkey, and finally because money poured in from Saudi Arabia, the United Arab Emirates, and Kuwait to the Sisi government. Money from the Gulf states was preferable because Egyptians associate the IMF with austerity and hard times. Unfortunately, delaying IMF involvement has legitimized popular fears—now IMF lending will indeed be accompanied by hardship.
Delaying IMF involvement has legitimized popular fears—now IMF lending will indeed be accompanied by hardship.
Accepting money from the Gulf allowed the government the freedom to design its own reform program. To Sisi’s credit, significant energy price reforms were made in 2014, with gas prices rising by an average of 42 percent. The reforms were initiated before oil prices fell, and then the large drop in world prices eased the adjustment for consumers. For a brief period, it seemed Egypt might follow through on IMF-style reforms, using Saudi money as a cushion.
But planned future energy price adjustments were delayed. And the real problem, the appreciating exchange rate, was not addressed. Pinned at 6 Egyptian pounds to the dollar for the first year and half after the revolution, with demand and investment falling and tourist revenue plummeting, the currency quickly became significantly overvalued. The government occasionally allowed the exchange rate to move in small steps but never enough, pulling it further and further from the free market rate. A black market developed, severe import shortages arose, and staples like flour and sugar became scarce and costly. Then in the fall of 2016, funding from Saudi Arabia disappeared in a dispute over the Red Sea islands, Egypt’s support of the Russian resolution for Syria in the UN security council, and its own fiscal problems.
As the balance of payments situation became more severe, the only place left to turn was the IMF. But the IMF cannot lend if there is a dual exchange rate. As the IMF talks intensified, the black market rate for the Egyptian pound grew to about twice the official rate. Letting go was hard. Finally, on November 3, the pound was floated. It rose from below 9 to the dollar to above 18 before settling around 16. This means that imported goods are now about twice as costly as before the adjustment.
The real exchange rate adjustment was necessary. Foreign exchange reserves had dropped to $15.5 billion in the middle of this year, barely enough to cover 3 months of imports. Shortages of imported goods were increasing. Exports were uncompetitive. Foreign investors were sitting on the sidelines waiting for the currency to crash.
The hope is that the devaluation in early November will make Egypt more competitive in the global economy and generate growth. Tourists will find Egypt to be a bargain, and demand for relatively cheap Egyptian exports will increase; imports will become more costly. Producers will shift into traded sectors, which now offer higher returns, and net exports should begin to contribute positively to GDP. Foreign investors are also expected to take advantage of Egypt’s growing competitiveness. The IMF predicts foreign direct investment will jump from 6.7 percent of GDP last fiscal year to 9.4 percent this year.
The challenge is that in addition to getting the prices right, investment and tourism require security. The government has closed gathering places in anticipation of riots and heightened military presence—which has so far preempted protests—but military action will reverse some of the predicted gains. Making matters more difficult, the country faces not only instability from protests but also more dire threats from terrorists. Aside from their human toll, attacks have been detrimental to the economy, with tourism falling to a near trickle this year following the downing of a plane of Russian tourists one year ago.
Other parts of the IMF program include implementing a value-added tax to expand revenue, business reforms to promote private sector growth, and cash transfers to the poor to protect the most vulnerable. Importantly, the plan also includes initiatives to help women work by providing nurseries and safe public transportation.
The hardest part may be that Egypt is undertaking these difficult but necessary reforms in a weak global economy, one where the Gulf is struggling under low oil prices, China is slowing, and Western sentiment is increasingly nationalist. The expansion of the Suez Canal, a major investment undertaken in recent years to raise foreign currency, came as world trade slowed. In such an environment, the exchange rate adjustment, like the Suez investment, may have only a limited growth effect in the near term.
Unlike other countries in the region, Egypt has the benefit of a large population, implying that domestic demand can more easily spur growth. Getting the population on board with reform is critical. In advance of the reforms, the government engaged in an educational campaign using billboards extolling reform and providing hope. Education is the right way to explain the choice, and hopefully it will help to limit protests and maintain confidence.
Overall, it will be a very delicate balance. The IMF got the exchange rate and other market-oriented reforms right. If there is one gripe to be had with the agreement, it is that the planned expansion of the social safety net, by about 1 percent of GDP, is not likely to be large enough. In addition, targeting assistance to the poor will leave the middle class with the brunt of the pain. More funding from other sources, such as the World Bank and European Bank for Reconstruction and Development, should be used to help ease adjustment.