Tougher reforms needed to support Egypt’s recovery

Published in MEED, 22 May 2018

Egypt’s economy has been through a tumultuous couple of years, but there are signs it is turning the corner, not least because of an IMF programme agreed in August 2016. That prompted the authorities to switch to a floating exchange rate in November of that year – leading to a sharp devaluation in the Egyptian pound – to make cuts to subsidies and to reform the taxation and regulatory systems.

Among the more significant moves, VAT was introduced in June 2017 and bills have been approved by parliament to overhaul the business environment, including bankruptcy, capital markets, industrial licensing and investment laws. The last of these, which also came into effect in June 2017, offers greater incentives and protections for investors. This has been widely welcomed.

The fruit of these, at times painful, reforms is now evident. Inflation is falling, the Central Bank of Egypt (CBE) has been cutting interest rates and the current account deficit has narrowed, helped by a rise in tourism receipts and other exports. The situation has been further boosted by the discovery of the offshore Zohr gas field in August 2015.

The economy is far from being out of the woods, however. Private sector activity is underwhelming and high unemployment remains a pressing problem. Even so, analysts are making more positive noises about the economy than has been the case for many years.

“There are some very deep-seated, fundamental problems with Egypt’s economy,” said David Butter, an associate fellow at UK think-tank Chatham House, speaking in London on 9 April. “But, in some respects, things have actually got a little bit better in the past two or three years.”

Inflation is perhaps the most obvious sign of improvement. In March, the consumer price index fell to 13.3 per cent, its lowest level since May 2016 and firmly in the CBE’s target range of 10-16 per cent.

As Jason Tuvey, Middle East economist at the UK’s Capital Economics, points out, the fall in inflation is largely because the devaluation of the pound has worked its way through the system – after the sharp drop in the value of the pound in late 2016 led to higher import costs and inflation of more than 30 per cent through much of 2017.

With the fall in inflation have come interest rate cuts. In March, the CBE cut the overnight deposit rate to 16.75 per cent. At the time of writing, the bank was expected to cut rates again on 17 May. At least one further cut is expected later in 2018, but there may be more, with some analysts predicting interest rates will end the year at about 14 per cent.

However, some price increases are also on the horizon. Because of subsidy cuts, fuel prices rose 50 per cent and electricity prices 42 per cent last year. This policy is far from finished however. Cairo plans to make further cuts to subsidies this year. The recent rise in oil prices has underlined the need to put this area of public finances on a more sustainable footing.

Another positive sign is the rate of GDP growth, which reached 5.3 per cent year-on-year in the final quarter of 2017. That compares with an average of 3.3 per cent over the previous seven years. The government is aiming for 5.8 per cent in the fiscal year 2018/19 and, while most analysts are more cautious, the consensus is that the recent growth rate is sustainable. Dubai-based Emirates NBD, for example, forecasts 5.2 per cent growth in 2017/18 and 5.5 per cent in 2018/19. US-based Moody’s Investors Service expects GDP to accelerate from 4.2 per cent in 2017 to about 5 per cent by 2019.

The improving picture is also being helped by stronger exports, not least in tourism, as well as by higher remittances from overseas Egyptians. Both factors are also contributing to a fall in the country’s current account deficit, which declined to $1.8bn in the second quarter of 2017/18, compared with $4.7bn a year earlier. This trend will be bolstered by gas production from the Zohr field, which is due to reach 2.7 billion cubic feet a day by 2019.

The improvements to the economy have enabled Egypt to borrow at reasonable rates. Gross debt rose above 100 per cent of GDP in 2017, but is now easing back. The interest rate Cairo pays on its debts could start to fall if credit ratings agencies make upgrades, as has been hinted at. The US’ Standard & Poor’s switched its outlook on Egypt to positive in November and said there was potential for an upgrade over 2018. In January this year, the US’ Fitch Ratings followed suit with a switch to a positive outlook.

There are still clouds on the horizon, however. Much of the recent growth has been driven by the public sector. The Emirates NBD-sponsored purchasing managers index has consistently pointed to falling activity in the private sector since late 2015. In April this year, it edged into positive territory, but only just – with a score of 50.1 points, putting it just above the 50-point mark, which separates contraction from growth.

As Daniel Richards, an economist at Emirates NBD, pointed out in a research note in late April: “In many ways the harder part of the reform process is yet to come”. Among other things he noted a need for “a fundamental overhaul of the economy [to] encourage greater private sector participation in key industries”.

Falling interest rates may encourage more borrowing from the private sector, which could boost activity and growth. Such developments would be welcome given that the economy is still not really growing quickly enough. While saying the current rate of growth is “obviously useful”, Butter said “it is not going to translate into any sustained improvement in Egyptian living standards until it reaches about 6 or 7 per cent.”

The IMF also expects more from the Egyptian authorities. In a speech in Cairo on 5 May, David Lipton, first deputy managing director of the IMF, praised the progress made in the past two years, but added: “Now the time has come to take advantage of the hard-won macroeconomic stability and push on to create jobs and raise living standards through sustainable growth. That may be difficult, but it would provide the payoff for all the efforts to date.”

What is needed, according to Lipton, is a broader reform agenda, which would include strengthening private sector activity and further opening the market to boost investment and exports. Whether Cairo has the desire and the strength to push ahead with further big reforms remains to be seen. There is always the chance that fundamental changes could lead to protests and social instability – something Egypt has had more than its fair share of in recent years. Nonetheless, further economic reform is unavoidable if Egypt’s economy is to thrive.