Egypt: Steadfast Reforms Key for Economic Stability, Jobs, Growth

Following four years of political uncertainty and economic slowdown, Egypt has chosen a path of adjustment and reform which, if followed resolutely, will lead to economic stability and growth, the IMF said in its first comprehensive assessment of the North African nation’s economy since 2010. Speaking to the IMF Survey, IMF Mission Chief for Egypt, Christopher Jarvis, noted that Egypt faces a challenge. On the one hand, it needs to put its fiscal and external accounts in order to restore macroeconomic stability. On the other hand, the Arab World’s most populous country needs to improve living standards for its growing population. Fortunately, he says, some of the same macroeconomic policies geared towards reducing the fiscal and external vulnerabilities can also help boost growth and jobs and reduce poverty. IMF Survey: The IMF has just concluded its first annual policy discussions with the Egyptian authorities, known as the Article IV consultations, since 2010. What’s the Fund’s assessment of the economy and the authorities reform plans? Jarvis: For a number of years, Egypt has suffered from insufficiently inclusive growth and high unemployment. Since 2011, these problems have been compounded by large fiscal deficits, rising public debt, fragility in the balance of payments and, hence, losses of foreign exchange reserves. Unsurprisingly, vulnerabilities have been increasing in the process. But things started to turn around in the last few months. The authorities have embarked on an economic reform program to raise growth, create jobs, and contain fiscal and external deficits and the loss of foreign exchange reserves. On the expenditure side of the budget, the government started to reform the system of energy subsides. It also started to get a grip on the public sector wage bill, which, as a result of a very complicated wage structure, had been rising too fast. On the revenue side, the authorities introduced higher tax rates for high earners, and a capital gains tax. Those measures have already made a big difference in curbing the unsustainably high fiscal deficit. Going forward, the fiscal program envisages gradual elimination of most fuel subsidies within the next five years. It also includes enacting a long-awaited value-added tax which, if implemented successfully, can greatly boost government revenues and, hence, improve the country’s fiscal position at large. To achieve inclusive growth, the authorities are pursuing structural reforms and developing measures to protect the poor. In this regard, there are efforts underway to streamline cumbersome regulations with the aim to improve the business environment and facilitate investment and job creation. To help the poor weather the reforms, the government is increasing cash transfers and spending on health, education, and infrastructure. Those programs should also give a boost to human and physical capital, productivity, and potential growth, which is very important for job creation. Looking ahead, some exchange rate flexibility would be needed to strengthen Egypt’s external position and support macroeconomic stabilization. A more flexible exchange rate policy focused on achieving a market-clearing rate and avoiding real appreciation would improve the availability of foreign exchange, strengthen competitiveness, support exports and tourism, and attract foreign direct investment. This would foster growth and jobs and reduce financing needs. This is all the more important as the US dollar strengthens internationally. In that respect, the recent movements of the Egyptian pound—about five percent depreciation against the US dollar—is a step in the right direction. IMF Survey: Does the economy face risks that could hinder the implementation of the reforms? If so, what can be done to arrest those risks? Jarvis: Clearly, Egypt is facing risks: the region is in turmoil, domestic security remains an issue, and the global economic environment isn’t supportive. We also expect the economy to face financing gaps over the medium term, which are significant though diminishing. Continuation with the reform plans, improvement in domestic security, and an even-handed application of the rule of law will help reduce vulnerabilities by increasing confidence in the economy. To keep the reform momentum, Egypt would benefit from continued support from the international community in terms of technical advice as well as financing, until the reform efforts bear fruit. But, we don’t only see risks; we see opportunities for Egypt as well. The country has good prospects for attracting foreign investors, especially if the government keeps up its reform efforts. The authorities will host a major economic conference in March. If successful, it could mobilize international financing, generate more private business opportunities, and motivate the country to improve its infrastructure. IMF Survey: Unemployment in Egypt, especially among the youth, stands at double digits. At more than 25 percent of the population, poverty is also a major socioeconomic issue. What should the country do to boost job creation and improve standards of living? Jarvis: Egypt faces what seems to be a daunting challenge. It needs to raise growth, create jobs, and reduce poverty but, at the same time, it needs to bring down the budget deficit and improve its external accounts. But, actually, there’s a way to overcome that challenge. Some of the same macroeconomic policies that help reduce the budget deficit and external vulnerabilities will also help with growth, job creation, and poverty reduction. One example of those policies is reduction of fuel subsidies. Those tend to benefit the well-off segments of the population—people who drive big cars, for instance—more than the poor. Furthermore, fuel subsidies tend to benefit capital-intensive industries whereas Egypt needs more labor-intensive industries to help reduce unemployment. The subsidy reform can change all these distortions. We think that, by increasing fuel prices, the government will be able to generate large savings to make more transfers to the poor and improve their living conditions, and invest in roads, schools, hospitals, and power plants. Another example lies in the role of exchange rate policies, which, with appropriate flexibility, can help develop exports of new industries, many of which can create jobs and support long-term growth. Structural measures to improve the business environment and make Egypt a more attractive place for investors will be important too. There are also steps that policymakers can take to make the financial system work better. For example, only 10 percent of Egyptians currently have bank accounts. Improving the diffusion of financial services and extending more credit to small job-creating businesses could help the economy in a big way. The authorities are well aware of that, and have recently adopted a microfinance law that could help in this respect. Finally, improving the educational system, partially through increased but efficient spending, is of paramount importance for Egypt’s long-term development. Again, this is an issue the authorities are cognizant of, and the rebalancing of spending towards health and education mandated by the constitution, if implemented efficiently, could support a higher, more inclusive growth in the longer term while preserving fiscal sustainability. IMF Survey: Besides policy consultations, how does the IMF currently help Egypt? Jarvis: We hope that the policy consultation itself has been valuable for Egypt, especially ahead of the March investor conference. We have provided our candid views on the macroeconomic outlook, which help give investors a clear picture about the economic progress that Egypt is making. The IMF has also been providing the country with technical assistance in a number of areas, most notably in the design of the value-added tax in an effective and fair manner. Finally, as the Managing Director said in a number of occasions, the IMF is also ready to provide Egypt with financial support if requested. Source: IMF Survey