The Egyptian government has issued a series of decisions meant to raise fuel prices in order to slash energy subsidies. The public plan previews a 40 to 50 billion cut in subsidies during the current fiscal year. The prices of some products such as gasoline, diesel (gas oil) and natural gas have already increased by almost 100 percent. Fears about the inflationary consequences of such measures are spreading, especially that diesel, which accounts for half of the total subsidy bill, is used in the production and distribution of most goods and services in Egypt. In fact, these inflationary effects have immediately been felt in the transportation sector where costs have already increased.
There is wide agreement among financial and economic experts that the subsidy system in Egypt is no longer sustainable in its current form. Egypt’s dependency on oil imports has risen since 2006 and with the severe energy crisis of the last few years, subsidies reached about 20 percent of public spending, namely 6 percent of the gross domestic product. However, experts disagree on the timing of these subsidy cuts and their subsequent economic and social cost mainly. Since the January 2011 revolution, the Egyptian economy has witnessed decreasing growth rates, a rise of unemployment and a decline of domestic and foreign investments, all of which has placed the country on the brink of recession.
Those opposing a current increase of fuel prices argue that, in the midst of a recession, such measures could lead the economy into stagflation with rising prices and declining growth rates. They believe that the Egyptian government is dealing with the issue of budgetary deficit and subsidies from a purely economic angle, focusing only on the digital deficit and discarding the impact of public demand on economic growth. They warn that these austerity measures are bound to harm the chances of economic recovery and deepen recession, which goes against the government plans intended to raise growth and employment rates. These measures might even jeopardize the legitimacy of the new regime and its leader, Abdel Fattah al-Sisi, who promised to restore stability and re-launch economic growth.
What, then, is the Egyptian government relying on to salvage the economy? And how does it plan to do so with austerity measures threatening to have dire consequences combining both recession and inflation?
The vision of the Egyptian financial team is based on two opposites: reforming the budget’s structural imbalances by cutting public spending, and subsidies in particular, on the one hand, and, on the other, increasing tax revenues in the coming five years. This would reduce both budgetary deficit and public debt, and would relieve public demand on the resources of the banking system. If achieved, these steps would reflect positively on credits to the private sector, which can be rechanneled to finance investments. This is much needed today because the Egyptian government, in its attempt to finance the growing deficit during the last decade, became the largest borrower from the banking sector—a situation that raised interest rates and significantly reduced the funding chances of non-governmental sectors. The financial team believes that the austerity measures designed to rectify financial imbalances could be counterweighted through cash flows from the Gulf, UAE and Saudi Arabia in particular, that would be provided as investments and would help raise global demand, employment and growth rates. This would subsequently break the cycle of recession, which Egypt has been battling since January 2011.
The truth is that, since June 2013, Egypt has indeed received around 20 billion dollars from the Gulf. The bulk of this sum, however, has been used to support the growing deficit in the budget and to subsidize fuel and has thus had little impact on economic recovery. The financial team, which is the economic policy maker in Egypt at the moment, argues that the only means to restore growth is to channel GCC funds away from supporting the public deficit and towards investments in productive sectors with major job-generating projects. This belief seems to be shared by GCC partners who link their future role in Egypt to the reform of structural imbalances in state finances. Hence, the Egyptian plan aims to achieve two targets, which may seem contradictory at first: adopting austerity measures over the coming years to reduce budget deficit, public debt, and debt service fees on the one hand, and without affecting global demand on the other. This can only be accomplished if funds from the Gulf are directly invested in the economy in the form of stimulus packages, even if they have to go through public institutions, like the armed forces, as is the case with the million housing unit project.
The plan looks similar to one adopted in the early nineties when the Egyptian government embarked on a deep structural reform using huge cash flows obtained from the Gulf following its involvement in the second Gulf War and as per the Paris Club agreement. At the time, these measures had succeeded in reducing public deficit. However, they were followed by years of recession, because the government was unable to increase exports, among other things.
Today, the Egyptian government seems incapable of withstanding such dire consequences. Therefore, the key to restoring economic growth and reforming public finance imbalances might lie in the expected impact of the long awaited GCC investments in the coming years. It also depends on a genuine belief among both local and foreign investors that Egypt is indeed moving towards political stability, which would justify any increase in potential investments in its economy.