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Neither Public nor Private: Egypt Without a Viable Engine for Growth

The IMF’s newest loan program involves a number of provisions, some promising and some worrying.

At 10:30 AM on January 11 in Cairo, the cost of $1 broke 30 Egyptian pounds (EGP) for the first time in the country’s history. To satisfy the conditions for Egypt’s latest loan from the IMF, the Central Bank of Egypt has been aggressively devaluing the Egyptian pound, as it moves to a full floatation of the pound, in which the country’s currency will now increase and decrease in value based on market forces rather than have its value set by the central bank. In under a year, the pound has already lost nearly half its value against the US dollar, dropping from 16 EGP to the dollar in March 2022 to around 30 EGP to the dollar at the time of writing, and it is still uncertain how low the pound may go.

The IMF’s new program in Egypt, built on a $3 billion loan from the Fund along with an anticipated $14 billion in additional financing is a Hail Mary to try to stabilize Egypt’s economy in the midst of the country’s latest financial crisis and hard currency shortage. Central to the IMF’s program is the Fund’s demand that Egypt transition to a permanent flexible exchange rate, hence the devaluation and moves toward a full float being witnessed currently.

The program involves a number of provisions, some promising and some worrying. They include new sources of tax revenue, an expansion of social protection, a reduction in energy subsidies, and “fiscal consolidation” (in other words, austerity). There is also a requirement to rein in spending on large projects and ensuring they are affordable, as well as provisions governing the sale of state assets and leveling of the playing field between public sector and private businesses.

The program has the ambitious objective of reducing the role of state-owned enterprises—in which the IMF includes military-owned companies—and encouraging their replacement with “inclusive private sector led growth.” Indeed, Egypt’s Prime Minister Mostafa Madbouly called for just that last year, saying he is aiming for the share of private investment in Egypt’s economy to rise from 30 percent to 65 percent in the coming three years. However, when one examines the market conditions in Egypt and globally, it becomes clear that such an expansion of private investment is clearly unrealistic.

Some recent history

For some perspective on what a tall order this is, Price Managers’ Index (PMI) surveys show that over the past seven years, Egypt’s non-oil and gas private sector has contracted for 75 of the past 84 months. The reasons for the private sector’s lengthy contraction are numerous, but one of the chief challenges cited by managers surveyed was weak domestic demand.

In the two years before the IMF’s 2016 bailout of Egypt, a hard currency shortage led the country’s central bank to impose capital controls and restrict access to a dwindling supply of hard currency, keeping them for imports of essential goods, external debt payments, and preserving the peg of the Egyptian pound to the US dollar.

During that time, a massive parallel market for hard currency emerged, with its own exchange rate. The parallel market even operated internationally, with Egyptian expatriate workers paying their Saudi rials or Kuwaiti dinars to dealers in the countries where they worked, who then had partners in Egypt who would disburse Egyptian pounds to awaiting relatives at the black-market rate. In 2015, before new reforms were introduced, the central bank governor at the time Hisham Ramez estimated that as much as 90 percent of Egypt’s remittances were being lost to the parallel market, circumventing the country’s official banking system and starving banks of much needed hard currency liquidity. For perspective on the seriousness of this issue, remittances in recent years have brought more dollars to Egypt than Suez Canal revenue, Foreign Direct Investment (FDI), and tourism combined.

Throughout 2015 and 2016, businesses bought dollars on the black market to finance their imports. This was necessary for sellers of imported goods as well as the many manufacturers who required imported inputs for their factories. Inflation rose, purchasing power declined, and the informal economy grew. Finally, when a deal was struck with the IMF in the fall of 2016 the Egyptian pound was ‘floated’ by Tarek Amer, Egypt’s new central bank governor. It soon became clear, however, that the pound was not floating and was just being surreptitiously pegged to the dollar at its newly devalued price, despite claims by Amer to the contrary. The Egyptian pound lost approximately half its value to the US dollar in the float/devaluation of 2016, contributing to a spike in inflation that exceeded 30 percent according to government statistics.

Consumers were cutting back on eating meat, chicken, and even vegetables as they struggled to meet the punishing rise in the cost of living. Local businesses suffered and struggled to find ready buyers with enough resources to sell to. Inflation was driven by the devaluation, a government printing money at an alarming pace, and IMF conditions of the loan such as the imposition of a 14 percent VAT on most consumer goods and the cutting of a series of energy subsidies on fuel, natural gas, and electricity. This caused the price of transportation, refrigeration, and manufacturing to rise even further. Inflation levels and the collapse of the pound reportedly surprised IMF officials who failed to anticipate such a dramatic deterioration.

These subsidy cuts and austerity measures were supposed to be offset with targeted cash assistance to those in need. However, the infrastructure for this was being erected while the spikes in inflation were underway, leaving tens of millions of Egyptians to endure years of economic pain without cash support.

Now, after several years of failure to meet their objectives, the IMF has launched its third loan program to Egypt and they believe the private sector will deliver growth for Egypt. Under the current circumstances, it seems difficult to understand how.

Today’s business environment

This is Egypt’s investment environment today:

The Egyptian pound has once again lost roughly half its value against the dollar in the past year. However, unlike in 2016, Egypt has not received an injection of hard currency and banks are still starved of dollars. This will hopefully improve when a full float is in place.

Inflation already pushed past 20 percent last month and this is only the beginning of a year or more of price corrections as markets absorb the latest dramatic devaluation of the country’s currency. While in 2016 and 2017 consumers cut back on beef and chicken, replacing them with eggs as a source of protein and fats, eggs today are too expensive for many, leading the government to encourage the consumption of chicken legs.

The new IMF program requires 20 million vulnerable Egyptians to receive cash transfers by the end of January, but three years ago when things were far less precarious, there were already 30 million Egyptians in poverty and the World Bank estimated 60 million Egyptians were near or below the poverty line. Today, poverty levels are almost certainly higher and despite a modest increase in social protection coverage, domestic demand in the coming year will likely weaken even further, as tens of millions of vulnerable Egyptians continue to endure economic hardship with no cash support.

On the horizon is a global recession likely to hit Egyptian manufacturers seeking global clients. Egyptian manufacturers also depend heavily on imported inputs whose costs have risen significantly, both due to global inflation and the now much weaker pound.

Finally, to combat inflation, the central bank has raised interest rates significantly while having state banks sell certificates of deposit that offer 25 percent interest to clients, in an effort to vacuum up liquidity and weaken domestic demand and, with it, inflation. This makes the cost of borrowing for would-be investors exorbitant, all while they could safely park their money in the bank and collect 25 percent interest. Moreover, the liquidity banks are removing from consumers is money that will not be available to buy consumer goods, further harming local businesses. Even in the West we are seeing central banks use elevated interest rates to depress domestic demand as they fight inflation. 

How many businesses will invest to start or expand in such a difficult market environment? What are the odds that the rate of investment will more than double as the Egyptian prime minister says he is aiming for?

No engine for growth

The IMF’s newest loan program finally begins to address major gaps in the past several years of its engagement in Egypt, trying to restrict waste and graft while getting specific about social protection targets. It also includes a long overdue and welcome condition that requires military companies to play by the same rules as the private sector. Nonetheless, the IMF appears unrealistic about the coming pain, estimating just 14 percent inflation in the coming year. They are also likely to be unrealistic about how quickly growth can be achieved. It is not just the private sector that will not grow in the near term due to the many deterrents facing Egypt’s business community. 

The IMF program also seeks to weaken, if not dismantle, Egypt’s admittedly unsustainable vehicle for growth for the past several years: the debt-driven government stimulus spending. Egypt’s GDP growth for the past several years was buoyed by enormous levels of public spending on roads, bridges, new cities (including a new capital city), massive rail projects including the world’s longest monorail line, and even a number of presidential palaces. 

Now that the state is being required by the IMF to cut unnecessary large project stimulus and its ability to borrow is heavily constricted, the country’s growth model is at risk of decelerating. This would leave Egypt without a public or private driver of economic growth; all as it plans to take on tens of billions of dollars in new debt. This could have worrying implications for the IMF’s calculations on Egypt’s debt sustainability. 

No wonder the IMF’s new report on Egypt’s loan is chock-full of warnings of risk. When assessing the health of Egypt’s debt exposure, IMF staff describe it as “sustainable but not with high probability,” adding “overall risks of sovereign stress are high.” Such sentiments do not encourage confidence from investors. 

The IMF has finally started to seriously engage with Egypt’s sizable governance issues and calls for reducing the size of the military’s economic empire which has done enormous damage to the country’s economy and private sector. That said, even if the IMF succeeds in holding the Egyptian government to its new commitments, the damage done is substantial. The IMF’s poorly designed previous economic programs, along with the regime’s self-enriching economic malpractice, leaves the country in a truly difficult state, all while global market conditions are exceptionally worrying.

Recovery will not come quickly. It will take years for Egypt to reach the levels of growth it needs. Hopefully the regime will not grow impatient and rob the country of its potential once more.

Timothy E. Kaldas is a Policy Fellow at TIMEP. He researches transitional politics in Egypt, regime survival strategies, and Egyptian political economy and foreign policy.


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