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When the Egyptian government signed an agreement with the International Monetary Fund in November 2016, it committed to the all-too-familiar austerity measures of subsidy cuts and tax hikes.
Wednesday 30, January 2019
(Bloomberg)--The agreement included the flotation of the Egyptian pound, which lost 50 per cent of its value overnight. In return, the Government of President Abdel-Fattah El-Sissi received a three-year, $12-billion-dollar loan from the IMF, part of a $21 billion package to build the country’s foreign-exchange reserves and fix its balance of payments.
A little over two years later, the IMF and the government are hailing the deal as a success. The Government has stuck by its commitment to slashing subsidies and raising taxes. Inflation, after climbing to over 30 per cent in 2017, has fallen to 11 per cent. Foreign reserves have risen, from less than $15 billion in late 2016 to $44 billion. Egypt’s credit rating has improved in tune with its macroeconomic indicators. Finally, the economy is showing signs of a spurt after more than six years of low growth rates.
Pronouncing himself satisfied, Egypt’s Finance Minister Mohamed Maait told Bloomberg he would not be seeking more funding from the IMF next year, when the $12 billion loan program ends.
But history tells us this won’t be the last time Egypt will turn to the IMF for help. Since the mid-1970s, it has returned repeatedly the Fund, seeking fixes for the same problems. This is because IMF packages only help overcome immediate financial difficulties but don’t address their root causes. This leads to recurring financial crises that usually start with foreign-currency shortages, mounting pressure on the national currency and high inflation due to huge trade and balance-of-payments deficits.
Egypt is a net food and fuel importer. It lacks a deep industrial sector and depends heavily on imports for essential production inputs—not only raw materials, but also capital and intermediate goods. By some estimates, production inputs made up more than 50 percent of the import bill in 2017. Exports have historically been less than half of imports; so, to raise the hard currency necessary to meet its external commitments, Egypt depends on workers’ remittances, tourism and, to a lesser extent, foreign direct investment.
These structural constraints are persistent, and they are forcing themselves upon the scene once again, potentially undermining the economic recovery.
Given the heavy import-dependency of Egyptian producers, the IMF deal had a negative impact on their sectors in 2016 and 2017. The sharp depreciation of the Egyptian pound meant higher production costs. It also caused inflation which, combined with other austerity measures, compromised the purchasing power of Egyptian consumers. The state’s expanding debt and higher interest rates crowded out the private sector.
It is true that, with macroeconomic indicators starting to stabilise in late 2017, productive sectors in the manufacturing and agriculture have been showing signs of life. But these signs expose the internal contradictions within the Egyptian economy. Productive sectors, which are crucial for job creation and the generation of real growth, cannot grow without substantially increasing imports. So, the recovery in the productive sectors has led to an increase in the trade deficit, which was up 30 per cent in October 2018 compared to October 2017. Foreign reserves held by the central bank fell $1.9 billion in January 2019, the first decrease in two years.
The Government’s response has been to cut imports, which points to another structural problem: Egyptian exports do not enjoy high elasticity and have not been able to capitalize fully on the cheaper pound. This means, the more the economy grows, the greater the pressure on dollar reserves. It doesn’t help that these were built up almost entirely through foreign borrowing, pushing Egypt’s foreign debt from $55 billion in 2016 to $92 billion in late 2018. It won’t be long before the country’s finances are once again in crisis.
The most reliable way to break out of this cycle is to develop a deeper industrial sector that is less dependent on imports. Egypt has shown potential in several areas for intermediate-goods production—like plastics, iron and steel, and chemicals—especially in the light of the recent oil and gas discoveries that provide some of the required raw materials. To promote these industries, the government should provide credit guarantees for manufacturers, and subsidize technology transfers. The manufacturers themselves should be able to take advantage of the weaker pound, which makes them more competitive against imports.
It may take years before Egypt is able to create the industrial depth it needs to reduce its import burden. But if it doesn’t start down that road soon, Egyptian finance ministers will be knocking on the IMF’s doors for a long time to come.