After floating the Egyptian pound on November 3 and subsequently cutting fuel subsidies on November 4, the Egyptian government cleared the final hurdles on its path toward receiving the first tranche of its $12 billion loan from the International Monetary Fund (IMF). The blockbuster deal comes after years of stifled efforts, countless calls for reform from a chorus of domestic and international economists, and numerous meetings between Egyptian and IMF officials. Although the IMF only finalized the agreement on Friday, November 11, the loan agreement and prerequisite reforms had already fundamentally altered the Egyptian economy in a way that only the most optimistic of observers expected.
As part of the terms of the package, Egypt agreed to implement a number of structural economic reforms, including a partial public stock offering of several state-run companies, the implementation of a much-lauded value-added tax (VAT) that had been in the works for several years, and a civil service reform bill to bring public sector salaries under control. Despite official denials that the VAT and civil service law were required for the IMF deal, both reforms were long-overdue undertakings to build trust among investors.
Most importantly, however, the IMF emphasized that Egypt must also liberalize its foreign exchange market and reform its energy subsidy program. Since the 2011 revolution, the prices Egyptians paid for imported goods and energy had diverged sharply from their actual costs in the global marketplace as a result of the fixed exchange rate set by the central bank. This policy was not without its advantages—the six Gulf Cooperation Council (GCC) members all used fixed exchange rates to the U.S. dollar or a basket of currencies to maintain steady domestic price levels for imported goods.
However, while the GCC countries had, for the most part, built up substantial foreign currency reserves to defend these pegs, Egypt had not. Egypt’s net international reserves fell from $36 billion in late 2010 to a nadir of roughly $13 billion in the summer of 2013 and have remained between about $15 and $20 billion since then—barely enough to cover three months of imports, as recommended by the IMF. Egypt’s foreign reserve woes were largely the result of attempts to defend an overvalued currency in the wake of the 2011 revolution, when the country saw its current account surplus turn into an ever-widening deficit. Tourism revenues, an important source of foreign currency, plummeted in the face of two deposed heads of state since the 2011 revolution and several high-profile security incidents involving foreigners. Heavily subsidized energy costs and a burgeoning middle class with an appetite for electronics also pushed imports higher. In other words, as fewer dollars were entering the Egyptian market, more were leaving.
Prior to floating the pound on the open market, the Central Bank of Egypt (CBE) had allowed its pound-to-dollar peg to fall from the pre-revolution exchange rate of roughly EGP 5.75 per dollar to EGP 8.88 per dollar for much of 2016. These prior devaluations aimed to counteract the increased utility of U.S. dollars following the removal of dollar deposit limits on bank accounts in Egypt. Yet despite initial praise from investors and a major upswing in Egypt’s equities market, this was not nearly enough. Businesses wishing to obtain foreign currency in order to purchase imports were faced with two options: wait in line and hope that they could access foreign currency through their bank, or turn to the black market, where some Egyptian manufacturers had been paying rates of more than EGP 18.00 to the dollar. As a result of this shortage in the foreign currency market, Egyptian businesses began cutting back on imports, and major multinational corporations threatened to pull out of Egypt due to the restraints they faced when trying to move profits out of the country.
The $12 billion IMF loan, as well as the $6 billion in foreign financing Egypt secured as a precondition for the final IMF approval and an additional $2.5 billion international bond coming at the end of November, will add some much-needed cushioning to the CBE’s international reserves. This will allow the government to finish paying back the $3.58 billion it owes to international oil and gas companies for energy products that were intended for export but appropriated for the domestic market. It will also allow Egyptian importers to regain access to the international market, clear the import backlog, and repay foreign suppliers.
Another purported advantage of securing the IMF loan is that it can “act as a catalyst for other lenders” and increase the confidence of foreign investors. This may be true to some extent, and many investors may reconsider Egypt given that the pound is now changing hands at roughly EGP 15.5 to the dollar. However, this rebound in confidence is likely to be limited so long as real reform comes only when there are no other options left.
The foreign exchange shortage did not happen overnight—the black market had been offering substantially better prices for dollar sales than the CBE for years. Efforts by the CBE to fight the black market with capital controls and dollar deposit limits shackled Egyptian businesses but did little to curb Egyptian consumers’ appetite for foreign goods. Instead, by waiting so long and being so risk-averse in the face of mounting economic crises, Egypt missed the opportunity to take advantage of relative historical lows in food and crude oil prices.
This foot-dragging on the part of the Egyptian government can be blamed for some of the recent inflationary pressure and market panics for a variety of goods as well. As Egyptian businesses imported less, domestic shortages in foodstuffs such as sugar sprang up, leading to hoarding, rationing, and inflation as an increasing number of pounds began chasing fewer goods. A lot of this inflation would have occurred eventually once the currency float devalued the pound, but by letting panic run through the domestic marketplace, the Egyptian government and CBE lost the ability to manage the price increases in an orderly manner.
Additionally, after a surprise move to slash fuel subsidies in July 2014, mere weeks after President Abdel Fattah el-Sisi first took office, the Egyptian government left subsidies untouched for more than two years. Despite this, spending on fuel subsidies continued to drop as a result of the collapse of oil prices in the global market. Fuel subsidies in particular should have made an easy target for austerity measures, as they largely benefit the wealthy: the richest 20 percent of the population reaps 46 percent of the total subsidy bill. Despite this, the Egyptian government again failed to capitalize on the relative strength of the Egyptian pound to make additional cuts to fuel subsidies. The government acted only when forced by the IMF, and cutting back subsidies immediately after the float of the Egyptian pound ironically resulted in Egyptian consumers paying less in U.S. dollar terms than they had before the subsidy cuts. In other words, while consumers will see higher price tags at the pump, the devaluation of the pound means Egypt’s balance sheet will be in worse condition.
Figure 1: Egyptian Fuel Prices Before and After November 4
In addition, the Egyptian government could face public distress and outcry at the price increases and shortages, as these could crystalize into a new protest movement. Thus far, the Egyptian public has largely not protested, but tensions are building. Future government missteps could catalyze the Egyptian populace to once again take to the streets. The mass demonstrations of 2011 and 2013 are still fresh in the minds of government officials, and the more senior government officials have also not forgotten the bread riots of 1977, triggered by a move to cut food subsidies.
In the face of mounting crises, the Egyptian government has shown a disconcerting tendency to maintain the status quo rather than seize the moment. Despite this, the government’s newfound faith in market liberalism has rightly been applauded. Reforms such as a floating currency and fuel subsidy cuts are not ends, but means to a stronger, more sustainable and prosperous economy. The decision to take the unprecedented $12 billion IMF loan and implement structural reforms offers a path forward that could be a turning point in the economic history of modern Egypt.
But this path is quite steep and riddled with pitfalls. A weaker domestic currency can easily lead to budget deficit increases, resulting in higher inflation. Higher taxes can quickly sour economic elites on the benefits of a reform program, leading to less buy-in from the most influential and well-connected citizens. And lowering subsidies can rapidly lead to civil unrest or revolution—for which Egypt has neither the money nor the patience.
Brendan Meighan is a macroeconomic analyst focusing on the Middle East.
