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Egypt: Good Progress to Date, but Sustainabil- Ity Requires Deep, Transformational Change

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Egypt: Good Progress to Date, but Sustainabil- Ity Requires Deep, Transformational Change Egypt: Good Progress to Date, but Sustainabil- ity Requires Deep, Transformational Change February 20, 2019 George Abed, Distinguished Scholar in Residence, [email protected], +1 202 857 3310 Chun Jin, Research Intern, [email protected], +1 202 857 3337 Boban Markovic, Senior Research Analyst, [email protected], + 202 857 3632 KEY POINTS • Egypt is making good progress on economic reforms in the context of an IMF-supported program. This is re- Exhibit 1: GDP Per Capita, 1980-2018 flected in higher growth, reduced deficits, a reformed ex- change regime and higher reserves. Current $, thousands 28 Korea 24 • Egypt is also making headway on the more pressing and long-debated structural reforms of fuel subsidies and is- 20 sues related to the business environment, thereby im- proving the immediate outlook. 16 Turkey 12 • However, to sustain the progress and to lift the growth trajectory durably over the long term, deeper and more 8 Malaysia fundamental reforms are urgently needed. EMs 4 Egypt • Prolonged neglect of deep-rooted structural distortions 0 1980-89 1990-99 2000-09 2010-18 has impeded Egypt’s ability to match its more successful EM peers in raising its standard of living and in reaping Source: IIF and IMF the full benefits of globalization (Exhibit 1). • While the current policy of incremental reform could EGYPT’S IMF-SUPPORTED REFORMS continue to produce marginal, albeit often impermanent Once more the IMF moved the goal posts and allowed Egypt improvements, the urgent need is for a serious reconsid- to pass the fourth review of the program agreed in 2016 and eration of the country’s growth model and its state-led thereby receive the penultimate $2 billion disbursement of a development strategy. $12 billion loan. To be sure, the Egyptian authorities have in fact implemented much needed macroeconomic reforms, in- • The approach needs to transform the role of the private cluding a sharp devaluation of the pound, some belt-tighten- sector to become the leading engine of growth while re- ing and interest rate hikes to combat inflation, and a partial ducing the dominance of the state in the functioning of reform of fuel subsidies. The authorities were supposed to markets and in direct economic activity. The state should focus on securing a healthy business environment for complete the reform of fuel prices to include cost recovery sustainable and inclusive growth. targets and indexation to international prices, but the task was only partially executed, a reason why the fourth review of the program was not completed on time last October. But • Finally, the reform program needs to phase out, gradu- now Egypt promised to complete the promised reforms by ally and, hopefully, non-disruptively, the role of the mil- itary in economic policy setting and in all commercial ac- the end of the program later in the year. The IMF in turn al- tivity that is extraneous to its core mission. lowed the disbursement of the $2 billion installment. But even if Egypt were to complete all the reforms written time, the state sector is comparatively large and is heavily into the program on time, that would have only scratched the weighed down by a bloated government bureaucracy and an surface. For beyond the long overdue and much debated unreformed public enterprise sector stuck in the past, state- macroeconomic reforms, there remain deep layers of struc- led development paradigm. Embedded in this sector is an in- tural inefficiencies and distortions that have plagued Egypt creasingly bold security establishment invested in its own economic performance for decades. The more obvious struc- sprawling economic and commercial dominion. Bolstered by tural impediments were identified in discussions with the the powers of emergency rule and determined to snuff out IMF, and a few of the these are being addressed by the au- any serious political challenge, the regime has also increas- thorities. These include completing work on new procure- ingly tightened its grip on the levers of economic power. The ment and competition laws, and the introduction of a new overriding objective of the Sisi regime appears to be to main- insolvency regime. Progress however, has been slow and if tain political stability at all costs and to prevent a fateful slide previous experience is any indication, it will be some time towards the ‘chaos’ of the Arab Spring rebellion. And given before such reforms produce the expected benefits. the imminent constitutional changes affecting Presidential term limits, the prevailing policy view could endure for many The deeper reforms needed to transform the Egyptian econ- years to come. omy, however, remain untreated. The overarching objective of the current program, as in the case of previous efforts at EGYPT HAS BEEN HERE BEFORE fundamental reform, has been to alter the structure of the In the past three decades, there have been at least two im- economy after decades of state-led development by gradu- portant episodes of attempted structural reform and both ally scaling back the overpowering role of the state in the ended with only modest and impermanent results. One was economy, and through an overhaul of the business environ- in the early 1990’s when Egypt was rewarded for its major ment, empowering the private sector to take the lead gener- role in the First Gulf War with considerable donor funds that ating high rates of inclusive and sustainable growth and were used to pay off debt and support a program of economic meaningful job creation. Reforming the social protection reform and privatization. Beyond a substantial reduction in program, including the decades-old system of consumption debt, and some temporary improvement in macroeconomic subsidies which was the focus of the current program, was to indicators, in large part because of aid inflows, actual results have been accomplished years ago. The failure to build a dy- of that program on structural reform were modest. namic, innovative and outward-oriented private sector to serve as Egypt’s growth engine has long been viewed as the The other, meaningful reform drive was undertaken by a main reason why Egypt has fallen short on matching its more pro-business government under President Mubarak in the successful emerging market peers in achieving high and sus- early 2000s. During that period, Mubarak’s own son, Gamal, tainable growth and in reaping the benefits of globalization. spearheaded the reform drive through his position in the rul- It was time therefore to reconsider the country’s growth ing National Democratic Party. The program again tackled model and development strategy. macroeconomic imbalances and addressed some non-fun- damental structural issues. The reforms achieved positive To many observers, it is now becoming increasingly clear results, including higher growth rates and a notable rise in that Egypt’s inability to fully execute on structural reform is foreign direct investment, some of which funded some pri- due to the resistance of a powerful state economic sector and vatization of public enterprises. But both the structural re- its unwillingness to yield the power and the privileges it has forms and the privatization campaign faced stiff resistance long enjoyed to a revitalized private sector that could con- from the ‘deep state’ and to some extent, from the public. In ceivably develop into a competing power center. At the same the end, the program’s accomplishments, substantial in Exhibit 2: Selected Macroeconomic Indicators, 1988-2020 2000-09 2010-16 2017 2018 2019f 2020f Real GDP growth, % 5.0 3.4 4.2 5.3 5.8 5.1 Unemployment rate, % 9.8 12.7 11.8 10.9 10.2 9.7 Inflation, average consumer prices, % 7.5 9.7 23.3 20.9 14.5 10.0 Current account balance, % of GDP 0.8 -3.1 -6.1 -2.4 -1.2 -0.8 Volume of exports of goods, % change 8.7 -3.8 12.5 9.3 9.0 7.0 Fiscal balance, % of GDP .. -11.1 -10.7 -9.5 -8.1 -7.0 Central gov’t domestic debt, % of GDP 64.0 69.4 77.4 70.3 62.5 56.8 Central gov’t external debt, % of GDP 20.7 23.6 30.0 30.0 32.7 34.2 Source: National Authorities, IIF and IIF Forecast for 2019, 2020 iif.com © Copyright 2017. The Institute of International Finance, Inc. All rights reserved. Page 2 some respects, became tarnished by claims of high-level cor- Exhibit 3: Current Account Balance, 1991-2018 ruption and quickly began to fade. It was not long before the reforms were abandoned with the onset of the 2011 Arab % of GDP $, billion 10 5 Spring uprising and the turmoil that followed. 8 0 THE PROGRESS TO-DATE 6 It comes as no surprise, therefore, that Egypt’s performance under the current Fund-supported program is showing une- 4 -5 ven outcomes. There has been some progress on the ‘low 2 hanging fruit’ of macroeconomic imbalances, but little dis- 0 -10 cernible movement on the fundamental reforms that would -2 ultimately lead to a reduction in the bulk and influence of the -15 state in the economy and to reinvigorating the role of the pri- -4 % of GDP $ billion (rhs) vate sector. -6 -20 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018 On the macroeconomic front, progress is notable (Exhibit 2): Source: IIF the currency has nearly stabilized at the new, sharply depre- ciated rate under a managed float regime with some positive impact on export receipts (especially tourism), growth has Exhibit 4: Fiscal Balance, 1991-2018 risen to 5.3%, unemployment is down but remains stub- % of GDP bornly high at 10%, global financial markets have responded 42 with strong inward capital flows, inflation has declined after a spike, to around 12%, while the current account and fiscal 32 deficits have narrowed, the former substantially so (Exhibits 22 3 and 4).
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