This article written by Hazar Caracalla, Senior Advisor at SRMG Think Research & Advisory, was originally published in Arab News.
Egypt’s economy is at an important crossroads as the country tries to lessen its reliance on aid and mega projects and reduce the public sector’s outsized role in a broad array of economic activities. Global financial shocks exacerbated by the Russia-Ukraine war have heightened the urgency of IMF-agreed efforts to reform Egypt’s economy. Egypt must accelerate fiscal consolidation, commit to a flexible exchange rate regime, and attract foreign investment as part of a sustainable, private sector-led business model. Reform will help make Egypt a prosperous and competitive partner in the Middle East’s economic transformation.
Egypt’s economy has experienced a build-up of imbalances, accelerated by difficult global financial conditions since the end of 2021 and shifts in investor sentiment towards the country, amidst a pegged currency. At the outbreak of the Russia-Ukraine war, Egypt witnessed massive portfolio outflows and widening sovereign bond spreads, thereby significantly increasing pressure on the Pound and on foreign currency reserves. Costs of living soared as the war drove up global food prices, exposed the country’s deep reliance on Russian and Ukrainian wheat, and cut off important tourism inflows from both countries, further increasing external and fiscal pressures. Egypt’s debt service has absorbed around half of total government revenue in recent years and the public debt to GDP ratio stands at around 90%.
In order to secure much-needed funding from the IMF, the Central Bank of Egypt has taken steps since October 2022 to make its exchange rate flexible. It has, however, devalued its currency through multiple “step” devaluations rather than allowing full flexibility to absorb external shocks. The “step” devaluations have so far failed to build investor confidence. As a result, Egypt is experiencing a severe shortage of foreign currency, with headline inflation having soared to 32% in February 2023.
The $3 billion IMF loan agreement, Egypt’s fourth such pact since 2016, has three main pillars. First, Egypt should implement a permanent shift to a flexible exchange rate regime to help absorb external shocks and rebuild foreign exchange reserves, while gradually reducing inflation through tight monetary policy. Second, Egypt must make reforms aimed at decreasing the debt to GDP ratio, contain its sizeable financing needs, strengthen fiscal governance and transparency, enhance revenue mobilization, and allow for a well-targeted and much-needed expansion in social spending. Third, Egypt should reduce the state’s outsized role in the economy including through the divestment plan and levelling the playing field by removing preferential treatment for state-owned and military-owned enterprises.
The IMF program may prove challenging for Egypt amid high financial uncertainty and increased global challenges. The IMF itself recognized in a December 2022 report that fiscal consolidation and the shift to a flexible exchange rate are not easy steps and could face political and social resistance. Furthermore, structural reforms take time to be completed and deliver results, while measures to reduce the state’s footprint in the economy could face opposition from interest groups.
Under previous loan agreements with the IMF, Egypt took notable steps toward devaluing the Pound, reducing subsidies and ensuring social safety net programs are better targeted. Egypt has also received substantial support from international and regional partners, including a total of $28 billion in central bank deposits from Gulf states. However, Egypt has not implemented meaningful structural reforms that could build economic competitiveness and secure stable currency inflows by developing a private sector-led industrial base, boosting exports, and attracting foreign direct investment. Instead, Egypt has continued to rely on volatile portfolio flows to finance its economy.
Egypt’s immediate priority must be to instil market confidence and attract strong, sustainable foreign currency inflows. Even the Gulf states, Egypt’s traditional Arab donors, have indicated a desire to shift away from unconditional direct financial support and towards economically and financially feasible investments. To secure such funding, Egypt should show investors quick and effective progress on economic reforms. An important policy test is its commitment to permanently shift to a flexible exchange rate regime and make progress on the divestment plan—central elements of the IMF program. According to the program’s financing strategy, divesting from state-owned assets would inject an estimated $8 billion of much-needed private sector financing into the economy.
Egypt met a key structural benchmark of the IMF program in December 2022, when President Abdel Fattah El-Sisi approved the State Ownership Policy Document. The document identifies economic activities from which the state plans to withdraw in the coming three to five years, and those in which it plans to increase or reduce its presence. It also lists several modalities for private sector involvement and underscores that fairness of competition will be ensured among all market players. Egypt’s government also recently announced plans to sell stakes in at least 32 publicly-owned companies and financial institutions by 2024. These important steps should be followed up with an elaborate execution plan and timetable to provide more clarity to potential investors. Implementation should move fast and in a transparent fashion to demonstrate progress and give evidence of continued political commitment to the divestment program.
A stable, competitive and prosperous Egypt is important to the MENA region, especially at a time when Gulf Cooperation Council (GCC) economies are undergoing momentous transformation. The region is witnessing a new dynamic driven by increased private investments underpinned by large oil and gas windfalls. Egypt is well-positioned to benefit from and contribute to this positive dynamic. For this to materialize, Egypt must wean itself off foreign aid, reduce the state’s footprint in the economy, and transition to a sustainable economic model built on strong exports with a solid manufacturing base supported by private investments. The alternative is a protracted cycle of macroeconomic instability, lower living standards and lost opportunities for the Egyptian economy.