Abstract

By the standards of recent experience with economic stabilization, Egypt in the 1990s is a remarkable success story. Determined macroeconomic policy, together with some favorable external developments, has brought much reduced inflation, led to improved public Finances, a stable currency, and a strengthened banking system, together with a sound balance of payments position. On the heels of a severe contraction in 1991/92–1992/93, given yearly population growth of over 2 percent, there is now increasing evidence of renewed private sector confidence manifested in rising investment, accelerating growth, and increased incomes.1

By the standards of recent experience with economic stabilization, Egypt in the 1990s is a remarkable success story. Determined macroeconomic policy, together with some favorable external developments, has brought much reduced inflation, led to improved public Finances, a stable currency, and a strengthened banking system, together with a sound balance of payments position. On the heels of a severe contraction in 1991/92–1992/93, given yearly population growth of over 2 percent, there is now increasing evidence of renewed private sector confidence manifested in rising investment, accelerating growth, and increased incomes.1

Against the background of impressive progress on stabilization, there has also been a reinvigoration of a program of structural reform. The objective, most evident since 1996, has been to promote private sector development and roll back the once pervasive scope of state controls. Building on reforms implemented earlier in the decade, considerable progress has been made in privatization, deregulating protected sectors, reducing distortions from pricing and subsidy policies, and removing other obstacles to trade and investment. Private investment is responding positively to liberalization and is increasingly the motor for growth.

Nonetheless, the task of delivering sustained growth of output and employment is incomplete. Investment and domestic saving rates remain low compared with successful emerging economies and, indeed, compared with earlier periods of state-led development in Egypt. Despite relatively competitive labor costs, labor-intensive production remains well below potential, while merchandise exports are limited and narrowly focused. In addition, structural impediments, which hold back rapid improvement of living standards, remain to be addressed in a range of sectors.

An Assessment of Stabilization

In 1990/91, at the outset of the adjustment program, the limits of Egypt’s state-led development policy had been reached. A major fiscal imbalance existed, with the central government deficit amounting to over 20 percent of GDP. Inflation was running at 20 percent. Several years of expansionary fiscal policy had led to an accumulation of debt to unmanageable levels with a commensurately heavy burden of debt service. Declining productivity growth was reflected in low growth and stagnant incomes per head. Weak export growth, excess domestic demand, and large debt-servicing costs were major factors in the current account deficit (before official transfers), widening to over 8 percent GDP, The authorities were reliant on exceptional financing, including accumulating arrears on external debt service. Confidence in the Egyptian pound was steadily ebbing; U.S. dollar bank deposits had risen to almost half the share of total domestic liquidity (Table 1 summarizes key indicators during the stabilization period).

Table 1.

Key Economic Indicators

article image
Sources: Data provided by the Egyptian authorities; and IMF staff estimates

Following the 1990/91 regional crisis, a concerted stabilization effort was launched based on four main principles:

  • Rapid reduction of the fiscal deficit. An upfront fiscal adjustment was achieved in the first year of the stabilization program with a substantive revenue effort and significant expenditure restructuring and reduction. Further steady progress in deficit reduction was made in each of the five successive years to 1996/97. On the revenue side, the main increases were based on adjustment of the exchange rate, which boosted Suez Canal revenues and oil company profits, as well as the introduction of a general sales tax. On the expenditure side, deep cuts were made in the extensive capital investment budget and significant reductions of untargeted subsidies were achieved while other expenditures, including wages, were relatively protected.

  • Currency and financial system reform. Early in the stabilization program major reforms were implemented in the financial sector to strengthen the banking system and develop effective monetary instruments to control liquidity. In early 1991, the different foreign exchange markets were effectively unified. Concurrently, official limits on interest rates were lifted and auctions for the sale of treasury bills were introduced. During 1992 and 1993, direct credit controls to private and public sectors were lifted.

  • Use of the exchange rate as a nominal anchor together with active management of liquidity. Starting in 1991, the exchange rate was de facto pegged to the U.S. dollar. An active sterilization policy was followed to dampen the expansionary impact of capital inflows using treasury bill sales with the proceeds deposited at the Central Bank of Egypt (CBE). The rapid accumulation of foreign exchange reserves early in the stabilization period amplified the authorities’commitment to the exchange rate peg and in turn led to reduced inflation expectations.

  • Improved poverty alleviation policies. To counteract the short-run effects of lower consumer subsidies during the adjustment program, Egypt created the Social Fund for Development (SFD) in 1991 to protect and improve the status of key vulnerable groups. The Social Fund for Development helped alleviate poverty through labor-intensive public works, support for micro enterprises, basic community services, retraining, and improved monitoring of living standards.

Impact of Key Stabilization Policies

The initially adverse effects of stabilization on growth were clearly felt in the first two years when the fiscal contraction was most evident, particularly in investment spending. Since 1993/94, growth has continued to pick up gradually and rising investment, primarily from the private sector, has helped to accelerate growth. The pace of investment and productivity during the stabilization period, however, has remained a concern, particularly in view of demographic pressures that entail rapid labor force growth. A central conclusion that emerges in Section II is that a further increase in the level and efficiency of investment will be required to deliver the official medium-term growth objective of over 7 percent; the estimated additional investment need, on the order of 6–8 percent of GDP, would depend upon a parallel increase in Egypt’s saving rate.

As regards Egypt’s fiscal position, the speedy reduction of central government borrowing, particularly from foreign sources, quickly reversed the debt stock buildup. The primary balance switched into surplus in the first year of stabilization and since then has averaged over 5 percent of GDP. Correspondingly, the debt stock dropped from 147 percent of GDP at the outset of stabilization to 90 percent in 1996/97. In conjunction with debt reduction and rescheduling, servicing payments have been substantially reduced, thereby reinforcing the initial fiscal adjustment.2 Notwithstanding the efforts already made, further efforts may be required to boost revenues over the medium term (Section III). A number of structural weaknesses in the tax base, notably the reliance on oil production, Suez Canal proceeds, and customs tariffs will likely produce declining revenues. Moreover, Egypt’s sales tax and income tax systems are administratively complex and relatively inefficient at generating revenue by regional standards. To this extent, a key fiscal objective is to press ahead with reform of the tax system to enhance efficiency and underpin efforts to further increase domestic saving, A number of important tax reforms, particularly with respect to sales tax, stamp duties, and corporate income tax, are in preparation.

Tighter control of liquidity growth quickly affected inflation; it was halved in the first three years of stabilization. Moreover, the liberalization of interest rates against the backdrop of falling inflation generated significantly positive real rates of interest on domestic deposits and, in the context of a stable nominal exchange rate, helped reverse dollarization. Also, Egyptian banks were able to increase interest margins and strengthen their capital and reserve adequacy. Section IV underscores the appropriateness of money-based stabilization policy and notes the difficulties of applying inflation targeting in the Egyptian environment.

Renewed confidence in Egypt’s stabilization effort together with broad exchange rate stability contributed to sizable capital inflows during the period 1991/92–1993/94 and 1996/97. These inflows, which peaked at 6 percent of GDP in 1991/92, posed a real challenge to the stabilization program. At the same time, to sterilize the impact of inflows on liquidity growth, the authorities undertook an active program of treasury bill sales. As a result of intervention to counter upward pressure on the pound, the CBE was able to build foreign exchange coverage from 7 months of imports in mid-1991 to 19 months by mid-1994. Since 1994, coverage has dipped somewhat yet remains well above that in most emerging markets. Section V notes that Egypt’s vulnerability to rapid outflows (e.g., from contagion effects) is greatly lessened by the strong fundamentals in the fiscal and current accounts.

The substantive reserve cushion has clearly reduced concerns over the durability of the exchange rate peg. Nonetheless, some concerns have arisen from domestic inflation running at rates somewhat above U.S. dollar price inflation. Thus, the real effective exchange rate (using relative consumer prices) has appreciated by 30 percent from its historic low point in mid-1991 to the end of 1996 and unit labor cost indices indicate varying degrees of real appreciation in the range of 25–60 percent over this period. Section VI suggests that the actual exchange rate has closely tracked the fundamental, or equilibrium, exchange rate throughout the post 1991 period, in contrast to the previous period when large and persistent deviations were observed. A central conclusion is that the reduction of the net present value of external debt through debt reduction during the stabilization period warrants a significant real appreciation of the equilibrium exchange rate.

The broader welfare impact of the stabilization program has been a recurrent theme in determining the pace and sequencing of reform. As outlined in Section VII, during the stabilization period to 1995/96 the incidence of poverty appeared to be stable, in part as a result of the targeted social safety net administered by the newly established Social Fund for Development. The reduction of subsidies during stabilization, notably on food, appears to have been achieved by focusing remaining expenditures on products consumed predominantly by target low-income groups, for example, particular types of bread. Moreover, the impact of public sector employment shrinkage has been cushioned by relatively generous severance payments. Nonetheless, it is clear that without accelerated growth and structural reform, the prospects for further improvements in health and education indicators, which lag behind regional averages, are limited.

The Challenge of Structural Reform

A sustained reinvigoration of Egypt’s structural reform effort is essential to strengthen investment and growth, in the context of integrated global capital and goods markets, as well as rapid regional economic liberalization: meeting the structural reform challenge will ensure that Egypt maintains its leading role in the Middle East. Competing in the global market requires further development of policies toward trade liberalization, privatization, public sector reform, structural fiscal reform, financial sector deepening, and measures to improve private sector incentives. In the regional context, Egypt, along with Israel, Jordan, Morocco, and Tunisia, is moving forward with nondiscriminatory trade liberalization, while negotiating association agreements with the European Union (EU). Moreover, regional economic integration will increasingly require harmonized trade and investment policies. As noted below, good progress has been made since early 1996 in several reform areas; however, more needs to be done to achieve Egypt’s ambitious growth targets.

Continuing efforts are needed to reduce the reach of the public sector in Egypt. The privatization program has been a notable achievement, particularly since being reactivated in 1996: more than one-third of the state portfolio has been divested, and divestiture proceeds have ranked high in comparison with other transforming economies. Privatization has focused on the divestiture of majority stakes of nonfinancial public enterprises and reducing state involvement in banking and insurance. As analyzed in Section VIII, for the strong pace of privatization to be sustained, a broader range of state assets will need to be added to the sales portfolio. In this respect, the authorities have moved toward a bolder privatization program that includes sale of a minority stake in the state telecommunications authority in 1998. Also, continuation of the privatization program, together with the creation of contestable markets in privatized sectors on an adequate regulatory framework, or both, will help raise productivity growth and domestic savings.

Egypt has traditionally had a strong “banking habit” with high levels of financial intermediation, notwithstanding extensive state controls in the sector. The progress of financial sector reform, as mentioned in the discussion of stabilization, initially focused on developing indirect instruments of liquidity management and enhancing the attractiveness of domestic currency banking assets through interest and credit liberalization. The second phase of reform in the financial sector aimed to increase competitiveness of financial markets by divesting state ownership of joint-venture banks and increasing private involvement in commercial banking, securities, and insurance. In large part, these reforms have underpinned an expansion of financial asset intermediation, particularly in the equity markets, and have contributed to a strengthening of banking profitability and bank soundness. These themes are reviewed in Section IX,

Liberalization of the external trade regime is a cornerstone to enhancing the competitiveness of Egyptian production. A review of progress made indicates substantial reductions of average tariffs since 1990/91, together with elimination of export duties and almost complete elimination of quantitative import restrictions. While this progress was marked by a substantial expansion of goods and services exports in the 1990s, reversing the trend of the late 1970s and 1980s, a number of significant concerns remain. One particular concern is that merchandise non–oil exports remain weak; volumes have barely shifted since the early 1990s and Egypt’s world market share has fallen. As discussed in Section X, a number of aspects of the trade regime continue to inhibit trade, notably restrictive quality controls, some tariff peaks and higher–than–average duty rates in a regional perspective, and cumbersome customs procedures, as well as problems in the foreign investment regime. Looking ahead, the prospects for future liberalization as a result of the Uruguay Round are relatively limited, as bindings were in general higher than applied rates. Bilateral agreements, particularly the Egypt–EU Association Agreement, which is close to finalization, and a continuation of unilateral actions in areas of concern will need to provide the impetus of reform.

Beyond Stabilization. Toward a Dynamic Market Economy
  • Ali Sonia M. Richard H. Adams, Jr. 1996The Egyptian Food Subsidy System: Operation and Effects on Income Distribution,” World Development Vol. 24 (November) pp. 177791

    • Search Google Scholar
    • Export Citation
  • Alonso-Gamo Patricia Susan Fennell, and Sakr Khaled 1997Adjusting to New Realities: MENA, The Uruguay Round, and the EU-Mediterranean Initiative,” IMF Working Paper 97/5 Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Barro,Robert, 1995, “Inflation and Economic Growth,” Quarterly Bulletin, Bank of England Vol. 35 (May), pp. 16676.

  • David B. Gordon 1983.A Positive Theory of Monetary Policy in a Natural Rate Model,” Journal of Political Economy, Vol. 91 (August), pp. 589610

    • Search Google Scholar
    • Export Citation
  • Berthelemy, Jean-Claude, and Aristomene Varoudakis 1996 Financial Development Policy and Growth Paris: Development Center of the Organization for Economic Cooperation and Development).

    • Search Google Scholar
    • Export Citation
  • Bisat Amer Mohamed A El-Erian, and Mahmoud E Gamal 1997Arab Economies Savings and Investment: Lessons from the Past and Torchlights for the FutureWashington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Mongelli Francesco P. 1996Investment and Growth in the Middle East and North Africa,” IMF Working Paper 96/124 Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Bisat, Amer, Mohamed A. El-Erian, and Thomas Hel-bling 1997Growth. Investment and Saving in the Arab Economies,” IMF Working Paper 97/85 Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Bruno Michael, and William Easterly 1995 Inflation, Crisis and Long-Run Growth, National Bureau of Economic Research Working Paper Series, No. 5209 (August)

    • Search Google Scholar
    • Export Citation
  • Calvo, Guillermo, Leonardo Lciderman, and Carmen M. Reinhart, 1993Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors,” Staff Papers, International Monetary Fund Vol. 40 March 1993 pp. 10851

    • Search Google Scholar
    • Export Citation
  • Cardiff, Patrick W. forthcoming, “Poverty and Inequality in Egypt,” Research in Middle East Economies Vol. 2 Cairo: Middle East Economic Association

    • Search Google Scholar
    • Export Citation
  • Clark Peter 1994, Exchange Rales and Economic Fundamentals: A Framework for Analysis, IMF Occasional Paper No. 115 Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Edwards, Sebastian 1989, Real Exchange Rales, Devaluation and Adjustment: Exchange Rale Policy in Developing Countries Cambridge, Massachussets: MIT Press

    • Search Google Scholar
    • Export Citation
  • 1994, “Real and Monetary Determinants of Real Exchange Rate Behavior; Theory and Evidence from Developing Countries,” Ch. 4 in Estimating Equilibrium Exchange Rales, ed. Williamson John Washington: Institute for International Economics 1994

    • Search Google Scholar
    • Export Citation
  • Elbadawi, Ibrahim A., 1994, “Estimating Long-Run Equilibrium Real Exchange Rates,” Ch. 5 in Estimating Equilibrium Exchange Rates, ed. John Williamson Washington: Institute for International Economics, 1994

    • Search Google Scholar
    • Export Citation
  • Fischer, Stanley, 1993, “The Role of Macroeconomic Factors in GrowthJournal of Monetary Economics, Vol.32 (December) pp. 485512

    • Search Google Scholar
    • Export Citation
  • 1996Central Banking: The Challenges Ahead, Maintaining Price Stability,” Finance Development, Vol. 33 (December) pp. 3437

  • Francois, Joseph, and 1995Assessing the Uruguay Round,” paper presented at a World Bank conference on the Uruguay Round and Developing Countries, January 1995.

    • Search Google Scholar
    • Export Citation
  • Frankel, Jeffrey, 1993, On Exchange Rates Cambridge, Massachussets: MIT Press

  • Frenkel Jacob A., and Assaf Razin 1982, Fiscal Policies and the World Economy Cambridge, Massachussets: MIT Press

  • Galal, A, 1996Savings and Privatization,” Egyptian Centre For Economic Studies (ECES), Working Paper No.8 Cairo, Egypt: ECES

  • Goldin, Ian, and Emmanuel van der Mensbrugghe, 1995, “The Uruguay Round: An Assessment of Economy-Wide and Agricultural Reforms,” paper presented at a World Bank conference on the Uruguay Round and Developing Countries, January 1995

    • Search Google Scholar
    • Export Citation
  • Goldstein M., and J. Frenkel, 1996 Functioning of the International Monetary System Washington: International Monetary Fund

  • Guitian Manuel and Saleh M. Nsouli, 1996 Currency Convertibility in the Middle East and North Africa Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Handoussa, Heba, 1990, “Egypt’s Investment Strategy, Policies, and Performance Since the Infttah,” Investment Policies in the Arab Countries, by El-Naggar Said Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Hansen, Bent, and Karim Nashashibi 1975, Egypt, a special conference series on Foreign Trade Regimes and Economic Development Vol. 4 New York: National Bureau of Economic Research

    • Search Google Scholar
    • Export Citation
  • Havrylyshyn, Oleh, 1997 A Global Integration Strategy for Mediterranean Countries: Open Trade and Market Reforms Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Hertel,Thomas, and others, 1995, “Liberalizing Manufactures Trade in a Changing World Economy,” paper presented at a World Bank conference on the Uruguay Round and Developing Countries, January 1995.

    • Search Google Scholar
    • Export Citation
  • 1996, Growth, Globalization and the Gains from the Uruguay Round Washington: World Bank

  • Ikram, Khaled 1980 Egypt: Economic Management in a Period of Transition Washington: Johns Hopkins University Press for the World Bank

  • International Monetary Fund 1994 Official Financing for Developing Countries, World Economic and Financial Surveys Washington International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • 1996 World Economic Outlook, World Economic and Financial Surveys Washington October

  • Marty, Alvin L., and Daniel L. Thornton, 1995, “Is There a Case for ‘Moderate’ Inflation?Federal Reserve Bank of St. Louis Review, Vol. 77 July/August pp. 27 37

    • Search Google Scholar
    • Export Citation
  • Mongardini, Joannes, 1998Estimating Egypt’s Equilibrium Real Exchange Rate,” IMF Working Paper 98/5 Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Pesaran M., Hashem, and Bahram Pesaran, 1996, Working with Microfii 4.0: Interactive Econometric Analysis Cambridge, England: Camfit Data Limited

    • Search Google Scholar
    • Export Citation
  • Pesaran, M. Hashem, and Yongcheol Shin, 1995, “An Autoregressive Distributed Lag Modeling Approach to Cointcgration Analysis,” DAE Working Paper No. 9514 Cambridge, England: Department of Applied Economics, University of Cambridge, February

    • Search Google Scholar
    • Export Citation
  • Quirk Peter, and Owen Evans, 1995 Capital Account Convertibility: Review of Experience and Implications for IMF Policies, IMF Occasional Paper No. 131 Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Ramaswamy, Ramana, 1997, “Monetary Frameworks: Is There a Preferred Option for the European Central Bank?” IMF Paper on Policy Analysis and Assessment 97/6 Washington: International Monetary Fund June

    • Search Google Scholar
    • Export Citation
  • Sarel, Michael, 1996Nonlinear Effects of Inflation on Economic Growth,” Staff Papers, International Monetary Fund, Vol. 43 March pp. 199215

    • Search Google Scholar
    • Export Citation
  • 1997Growth and Productivity in ASEAN Countries,” IMF Working Paper 97/97 Washington: International Monetary Fund

  • Schadler Susan, Maria Carkovic, Adam Bennett, and Robert Kahn, 1993 Recent Experiences with Surges in Capital Inflows, IMF Occasional Paper No. 108 Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Selody, Jack, 1990, “The Goal of Price Stability: A Review of the Issues,” Bank of Canada Technical Report, No. 54 May

  • Shiells, Clinton, Arvind Subramanian, and Peter Ui-monemEffects of the Uruguay Round on Egypt and Morocco,” IMF Working Paper 96/7 Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Stein, Jerome L., 1995The Fundamental Determinants of the Real Exchange Rate of the U.S. Dollar Relative to Other G-7 Currencies,” IMF Working Paper 95/81 Washington International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Subramanian, Arvind, 1997The Egyptian Stabilization Experience: An Analytical Retrospective,” IMF Working Paper 97/105 Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Tsikata, Tsidi, 1998, “Aid Effectiveness: A Survey of Recent Empirical Literature,” IMF Paper on Policy Analysis and Assessment 98/1 Washington: International Monetary Fund

    • Search Google Scholar
    • Export Citation
  • Wijnberger, Sweder van, 1986, “Aid, Export Promotion and the Real Exchange Rate: An African Dilemma,” World Bank DRD Discussion Papers, Washington: World Bank

    • Search Google Scholar
    • Export Citation
  • Williamson, John, ed. 1994 Estimating Equilibrium Exchange Rates Washington: Institute for International Economics