Portraits of Egyptian Pound notes and coins on October 12, 2016. (Photo by David Degner/Getty Images).
Analysis

Egypt’s Next IMF Loan: How to Avoid the Failures of the Past Six Years

In 2016, the International Monetary Fund (IMF) lent Egypt $12 billion, launching a program of economic reform and austerity. Six years later, Egypt is returning to the lender of last resort for the third time, because the 2016 program failed in its primary objectives. Central to this was the failure of planners to center governance as a condition for the loan, to prevent the squandering of the funds by regime elites while the economic struggles of the rest of the population worsened. The IMF and its shareholders now have a new opportunity to correct their past mistakes. It is not too late to encourage Egypt to undertake difficult reforms; these can unleash the country’s potential, rein in the regime’s economic malpractice, and set the country on the path to sustainable and inclusive private sector-led growth and increased labor force participation. Only then will there be the macroeconomic stability that IMF planners and Egyptian officials insist they are targeting.

The 2016 IMF program failed in its objectives

Egypt has attracted a lot of praise from international financial institutions like the IMF, the World Bank, and the European Bank for Reconstruction and Development for the economic reforms launched in 2016 and the modest GDP growth that the country has sustained in the ensuing years. International financial institutions were particularly pleased to see Egypt abandon subsidies on fuel, natural gas, and electricity. Yet any objective assessment of the goals of the program would have to conclude that overall, it was a failure. The 2016 program had a series of objectives: It aimed to facilitate inclusive private sector-led growth, increase labor force participation (especially among women), attract foreign direct investment, and strengthen Egypt’s macroeconomic stability. None of these objectives were satisfactorily achieved. On the contrary, Egypt’s economic performance deteriorated on most of these indicators.

On inclusivity, the numbers are clear: Today, the official poverty rate is 29.7 percent, when it was 27.8 percent in 2015. Even so, the official poverty line is well below the international standard of $2 per day, even before the recent devaluation of the Egyptian pound. Furthermore, observers have cast doubts on the integrity of the official figures and criticized international financial institutions like the IMF for repeating them unquestioningly. For its part, the World Bank estimated in 2019 that 60 percent of the population lived below or near the poverty line, indicating that a sizable majority of Egyptians remained economically vulnerable. In addition, labor force participation has declined precipitously, especially for women for whom it has fallen from 23 percent in 2016 to 15 percent in 2020. This is another indication that growth has failed to be inclusive. Moves to control the public wage bill hit women in the labor force particularly hard as they are disproportionately hired by the public sector.

As for private sector-led growth, it has failed to materialize. In fact, Egypt’s non-oil and gas private sector has contracted for 63 of the past 72 months. Foreign direct investment outside of oil and gas has also been largely anemic. Many foreign firms balk at entering Egypt’s convoluted market marred by poor governance and rule of law, and face the risk direct competition with companies owned by the Egyptian Armed Forces.

When it comes to macroeconomic stability, the 2016 IMF program helped bolster perceptions of Egypt’s creditworthiness in capital markets, and allowed the country to sell its domestic debt to foreign funds. This both helped the government access additional financing while attracting vital inflows of dollars. However, these funds, commonly referred to as hot money, were largely focused on short term debt that often matured in the span of six to 12 months and their commitment to Egypt was highly fragile. With every indication that risks were elevated due to Egypt’s domestic challenges and shifts in international markets, the country experienced massive capital flight, precipitating a financial crisis that forced Egypt to return to the IMF in 2020 for additional emergency support. Buyers of Egyptian debt were spooked again this year with many deciding to reduce or eliminate their exposure to Egyptian debt. This resulted in $20 billion in outflows thus far in 2022, which, in turn, contributed to Egypt needing to return to the IMF for a third loan in less than six years.

While Egyptian and IMF officials often suggest that unforeseen external shocks like the pandemic and Russia’s invasion of Ukraine explain Egypt’s current difficulties, many of these economic problems predate these two crises. If we look at Egypt’s economic performance by 2019, we would still find elevated poverty, labor force participation in steady decline, and persistent private sector contraction.

The IMF program was failing before any of these external shocks hit Egypt and global markets.

Why did the IMF fail?

Central to the failures of the 2016 IMF program was the lack of consideration for the array of governance failures that contribute to Egypt’s poor economic performance. Many damaging practices that deterred investment—both foreign and domestic—actually accelerated following the 2016 bailout as the program and Egypt’s perceived economic stability helped give the regime access to huge amounts of new financing from private and bilateral lenders.

The government used this opportunity to expand spending on arms, vanity projects, and megaprojects of dubious economic value and funneled much of the contracts for these projects through regime owned enterprises (ROEs), particularly those owned by the Egyptian Armed Forces. This trend is exemplified by the decision to build a new administrative capital, whose construction is being overseen by a company that is majority owned by the Egyptian military. However, there are an array of other infrastructure projects financed through debt driven stimulus that have been contracted to regime-owned enterprises, often without competitive tendering processes. ROEs are distinct from state-owned enterprises because the state is not authorized to audit or access the finances of ROEs and their profits do not remit back to the state.

The expansion of regime-owned enterprises has had a uniquely harmful impact on Egypt’s economy. They often do not execute the projects the state contracts them to complete. Instead, they subcontract to the private sector ensuring a relationship of dependence between Egypt’s struggling private sector and ROEs, and thus the regime itself. The whistleblower, Mohamed Ali, who fled to Spain and published a series of critical videos on military spending on presidential palaces and luxurious hotels, was one such subcontractor. Aside from giving regime elites access to a valuable source of rents, this dynamic ensures the regime retains an explicitly dominant position vis-à-vis civilian business elites, precluding the re-emergence of a center of power among Egypt’s crony capitalists, as occurred in the latter half of Hosni Mubarak’s tenure.

With privileged access to capital from the state and state banks, regime-owned enterprises have been able to expand in virtually every imaginable sector in Egypt’s economy including fisheries, agriculture, film and television production, bottled water, tourism, property development, cement and steel manufacturing, vehicle assembly, and even private education.

This aggressive expansion has led many with excess capital in Egypt to put their money in high interest deposits and real estate speculation, perceived to be less risky than competing with an expanding business empire that pays no tax, no VAT, no customs, has access to subsidized inputs, and, at times, uses military conscripts as laborers. In addition, the officers who control this business empire sit atop a violent autocratic regime without serious regard for the rule of law. According to the World Justice Project, Egypt ranks 136 of 139 nations on rule of law. Even those who subcontract for ROEs privately complain about partial or delayed payments for their work and the inability to challenge their contractor given their extraordinary political power.

Additionally, repression of the press denies both investors and consumers access to reliable economic data. Egyptian consumers are regularly blindsided by sudden economic shifts as there is little critical reporting available to the public with hundreds of websites, including many news sites, blocked inside the country. This problem is exacerbated by the dubious reliability of official economic data. Tarek Amer, the governor of the Central Bank of Egypt continues to insist that the Egyptian pound is free floating despite evidence that this has not been the case since at least 2018, when the central bank was found to be using state banks to control the value of the Egyptian pound. This manipulation misleads consumers and undermines investor confidence. Now that Egypt is under pressure to weaken its currency, investors will be all the more concerned about the sustainability of the central bank’s surreptitious currency manipulation and how it may affect the value of their investments.

Finally, the failure to take proper measures to mitigate the economic impact on Egypt’s sizable vulnerable population resulted in extraordinary hardship for much of the population, and further damaged the economy in general, and private sector performance in particular. The IMF and the World Bank have promoted targeted cash assistance in lieu of ‘leaky’ subsidies. While on paper this seems reasonable, the IMF did not set benchmarks for the level of coverage Egypt’s new cash assistance programs should reach. According to the World Bank, the number of beneficiaries by 2020 was 11.1 million people, less than half of Egyptians estimated to live below the poverty line. This means that nearly 20 million Egyptians living in poverty—and very possibly more as targeting of beneficiaries is imperfect—endured several years of punishing austerity measures with zero cash assistance. In a press conference in March, following the devaluation of the pound this year, Prime Minister Mostafa Madbouly, announced that 450,000 families—1.8 million people—were added to cash assistance programs, but this means that at least half of Egyptians living in poverty would still not be reached by those programs. While subsidy cuts have an immediate inflationary impact, the cash assistance programs meant to replace subsidies take years if not decades to fully roll out, leaving tens of millions of vulnerable Egyptians to fend for themselves in the meantime.

Purchasing Managers’ Index (PMI) surveys consistently cite depressed domestic demand as one of the reasons for the contraction of the private sector, as the purchasing power of Egyptians was slashed by the collapse of the pound in 2016, and the historical inflation levels in the initial years of the reform program. This inflationary impact was exacerbated by the regressive sources of tax revenue the government pursued, often encouraged by the IMF. A new VAT system—easier to implement than addressing income and corporate tax evasion—was put in place, while persistent increases in rates of customs further compounded inflationary pressure on Egyptians, in a country that heavily depends on imports. Cuts to energy subsidies as well as increased fees for government services and public transportation all added economic strain to an already highly vulnerable population.

How to avoid another failed IMF program 

There is an array of steps needed to improve Egypt’s economic performance. However, the following conditions on the next IMF loan could help reduce the risk of the failures witnessed in the past six years, and start to rein in the damaging practices that have deterred private investment and prevented inclusive growth in Egypt.

1) Transparent Competitive Tenders: All tenders, both for state contracts and the sale of public assets, including the Egyptian Armed Forces’ regime-owned enterprises, should be required to be conducted through competitive and transparent tenders. This will help reduce the risk of graft and force ROEs to compete more fairly with private firms. If fewer than three bids are secured for a state contract, the tender must be extended or reissued. Scrutiny of potential buyers will be needed to prevent regime elites in the private sector from unfairly securing control of public assets, as happened during the Mubarak-era privatization drive. Additional scrutiny should be exercised on deals that involve companies, with a current or past state official as member of the board or as an owner.

2) The revenue from the sale of public assets should remit to the state: To help stabilize the government’s finances and place them on a more sustainable footing, the revenue from the partial or total sale of privatized companies should go to state coffers. No state institutions, including the Egyptian Armed Forces, should be able to retain revenues. All assets and finances must be subject to transparent and verifiable audits to minimize risks of corruption and hidden assets.

3) A fair playing field in all markets: All companies, irrespective of ownership, should be required to pay the same taxes, VAT, and customs, and be subject to the same regulatory frameworks. Access to state land purchases and leases should be conducted through a unified transparent structure to prevent regime-owned enterprises from having an array of privileges that deter private investment and deny the state much needed revenue as they currently pay no taxes, among other things. In addition, conscripts should not be permitted to engage in any economic activity, and all laborers must be compensated by the hiring company in accordance with Egyptian labor laws.

4) Strict benchmarks for poverty assistance programs coverage: The IMF should set a brief achievable timeline for a 100 percent coverage of Egyptians in poverty through the country’s targeted cash assistance programs Takaful and Karama. Efforts should be made to improve the integrity of collecting poverty data and setting a credible poverty line that reflects the realities on the ground. Investments should be made—perhaps in cooperation with the World Bank or USAID—to develop a robust and continuous mechanism for assessing which Egyptians are in poverty and get them timely access to cash assistance.

5) All new tax revenue should be from progressive sources: To prevent further harm to vulnerable Egyptians and undermining domestic demand, efforts to increase government revenue should strictly target progressive sources, such as capital gains, progressive income tax, corporate taxes, and tax on luxury and vacation properties.

6) Protect the public’s access to information: Egyptian authorities should unblock news sites, release all journalists currently detained, and refrain from further harassing and repressing the country’s press. Markets benefit from the free flow of information, as consumers and investors have a right, and a need, for accurate information about economic developments in order to make informed financial decisions.

7) Improved rule of law and independence of the judiciary: As was required in the IMF program in Ukraine, an internationally verifiable effort to reform the judiciary and improve rule of law in Egypt is needed to restore investor confidence and establish a reliable, efficient, and orderly mechanism for dispute resolution within Egypt’s legal system. At the moment, many firms rely on international arbitration due to a widespread lack of confidence in Egypt’s legal system.

This list is not exhaustive, but it is a good starting point for building improved governance conditions into the next loan agreement. It is important that the IMF communicates clearly that failure to comply with the agreement will lead to a halt in disbursing future tranches and transparent public reporting on Egypt’s lack of compliance.

While some may doubt the leverage the IMF currently possesses, in reality, Egyptian officials lack good alternatives for financing. The IMF program is crucial for Egypt to be able to regain access to international credit markets and other bilateral lenders. Financial support from the Gulf has gotten much press attention but it is costly as Egypt’s Gulf partners are focused on specific investments, such as the UAE buying the government’s shares in Fawry, a highly profitable Egyptian company with substantial growth potential. These are not the generous financial aid packages Egypt received in 2013. China’s appetite for Egypt is limited and Chinese banks financing the new administrative capital have shown concerns over Egypt’s ability to repay its debt. Moreover, Chinese engagement does not send a comparably powerful signal to credit markets that comes with an IMF program.

The failures of the past six years should not, and need not, be repeated. These steps can help contribute to a more successful program that will extend economic benefits to a public that has so far suffered economic pain without any of the promised economic gains.

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.