Arab Republic of Egypt: Request for Extended Arrangement Under the Extended Fund Facility
Author:
International Monetary Fund. Middle East and Central Asia Dept.
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Publication Date:
18 Jan 2017
eISBN:
9781475566901
Language:
English
Keywords:
ISCR; CR; authority; deficit; Egyptian pound; rate; economy; financing gap; General government operation; reform program; policy stance; priority area
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Egypt's underlying structural weaknesses and the prolonged political transition have led to the build-up of macroeconomic imbalances. A significantly overvalued exchange rate has undermined competitiveness and depleted international reserves. Weak revenue combined with poorly targeted subsidies and a growing public sector wage bill have resulted in persistent large fiscal deficits and a high level of public debt. Real and potential growth have slowed since 2011 as foreign exchange shortages and the weak business climate deterred investment and impeded productivity improvement and job creation. Regional instability and security concerns have also taken a toll on the economy, especially on tourism. Risks of economic distress increased.

Abstract

Egypt's underlying structural weaknesses and the prolonged political transition have led to the build-up of macroeconomic imbalances. A significantly overvalued exchange rate has undermined competitiveness and depleted international reserves. Weak revenue combined with poorly targeted subsidies and a growing public sector wage bill have resulted in persistent large fiscal deficits and a high level of public debt. Real and potential growth have slowed since 2011 as foreign exchange shortages and the weak business climate deterred investment and impeded productivity improvement and job creation. Regional instability and security concerns have also taken a toll on the economy, especially on tourism. Risks of economic distress increased.

Economic and Political Context

1. Egypt has long struggled with problems of low and non-inclusive growth, high fiscal deficits, and external vulnerability. The country suffers from high unemployment and has 700,000 young people entering the workforce every year. Persistently low tax revenue and excessive public spending, including on subsidies, have led during a period of turbulence to high deficits and now uncomfortably high public debt. Low non-oil exports and lack of private foreign capital have contributed to recurrent balance of payments problems, while high inflation and a fixed exchange rate led to a significant overvaluation of the Egyptian pound and the erosion of international reserves. Foreign exchange and energy shortages, and the unfavorable business climate caused growth to slow. Security concerns and occasional terrorist attacks have seriously damaged tourism.

2. The political transition has now been completed. A newly elected Parliament convened in January 2016, completing the authorities’ political roadmap following the adoption of a new constitution in January 2014 and the inauguration of President Sisi in June 2014. The economic team in the executive branch has seen appointments of a new central bank Governor in November 2015 and a new Minister of Finance in March 2016.

3. The authorities are requesting Fund support under a three-year EFF arrangement to help them overcome the immediate policy challenges and the long-standing structural problems. In addition to achieving macroeconomic stabilization, the program envisages a package of reforms aimed at strengthening the environment for private sector development, and promoting inclusive growth and employment in the medium term. The authorities also appreciate the credibility that a Fund-supported program offers, as well as its catalytic effect in mobilizing external financing. The proposed policies are expected to address Egypt’s problems durably, but they also seek to find a balance between ambition and feasibility.

Recent Developments

4. Political instability and regional security concerns have taken a significant toll on the Egyptian economy. The growth slowdown, which started in 2008/09, accelerated after the 2011 revolution, with GDP declining well below its potential. Investment and exports fell, while consumption, supported by remittances from abroad and the government’s current spending, has gained ground. The overall fiscal deficit widened from 7–8 percent of GDP prior to the revolution to 10-13 percent thereafter. Public debt increased from 70 percent of GDP in 2009/10 to 89 percent in 2014/15 (fiscal years end in June), and interest payments reached almost one third of total budget spending (nearly 9 percent of GDP). The deficit was primarily financed through borrowing from the banking system, about one third of which was direct financing from the central bank. Accommodative monetary policy kept inflation elevated and with a fixed exchange rate led to significant overvaluation of the pound and growing balance of payment pressures. The current account deficit rose while private capital inflows including FDI fell, and foreign exchange reserves declined from nearly 7 months of imports in 2009/10 to 3½ months in 2014/15.

5. Faced with the mounting macro imbalances the authorities initiated policy adjustment measures in 2014/15. The Central Bank of Egypt (CBE) devalued the Egyptian pound by 5 percent and raised interest rates to contain inflationary pressures, while fiscal consolidation was pursued though subsidy, tax, and civil service reforms. Taking advantage of the softening global oil market, fuel and electricity prices were raised, and a plan for a gradual phasing out of these subsidies was developed. As a result, the subsidy bill fell by nearly 3 percentage points of GDP and the budget deficit narrowed from over 13 percent of GDP in 2013/14 to 11.5 percent in 2014/15.1 The decision was also taken to replace the General Sales Tax with fairer and more efficient VAT, and planning began on this. In addition, a new Civil Service Law was drafted to streamline the public employment framework. These actions were welcomed by the private sector and the international community, and Egypt returned successfully to international capital market by issuing a $1.5 billion Eurobond in June 2015. The construction of the parallel Suez Canal, investment in power generation capacity, and the discovery of major gas fields in Egypt’s territorial waters in the Mediterranean also produced a positive growth momentum. Real growth recovered to 4.2 percent in 2014/15.

6. In 2015/16, however, the momentum of reform slowed. Income tax rates were cut, the capital gains tax was postponed, and parliamentary consideration of VAT was delayed to 2016/17. On the expenditure side, planned fuel price increases were deferred, but total subsidies still declined by 1.1 percent of GDP, reflecting lower world oil prices. However, interest payments increased by 0.9 percent of GDP due to higher public debt. As a result, the 2015/16 deficit widened to 12.1 percent of GDP, compared to the budgeted 8.9 percent, and general government gross debt reached almost 95 percent of GDP.

7. Growth in 2015/16 slowed again while inflation increased. The economy is estimated to have grown by 3.8 percent in 2015/16.2 Foreign exchange shortages and the overvalued currency hampered the manufacturing sector. Tourism was hard hit by security concerns and the flight bans following the crash of a passenger plane over Sinai Peninsula in October 2015. Inflationary pressures intensified in the second half of the year, with headline inflation rising from around 9 percent in early 2016 to 14.1 percent in September. Core inflation increased from 9 to 13.9 percent.

8. External vulnerabilities also increased. The current account deficit further widened from 3.7 percent of GDP in 2014/15 and to an estimated 5.5 percent of GDP in 2015/16. The balance of goods and services worsened by about 1 percent of GDP. In June 2016, gross international reserves stood at $17.1 billion, equivalent to 3.1 months of prospective imports and 76 percent of the Fund’s reserve adequacy metric (ARA) for floating regimes and 45 percent for fixed regimes. The Saudi Arabian government’s agreement to provide oil import financing of about $4 billion per year for five years eased external pressures, but not sufficiently to fully address the country’s foreign exchange needs. External public debt remains relatively low at less than 20 percent of GDP.

9. In March 2016 the official exchange rate of the pound against the U.S. dollar was devalued by 13 percent. Nevertheless, strong pressures on the exchange rate and reserves remained, and market equilibrium was not restored. By end-September the parallel market premium widened to more than 30 percent, and the official exchange rate was estimated to be overvalued by about 25 percent in real effective terms, while foreign exchange shortages continued.

10. The aggregate financial soundness indicators through June 2016 point to the resilience of the banking system. The level of capital appears adequate with the ratio of regulatory capital to risk-weighted assets at 13.7 percent. Nonperforming loans as a share of total loans are reported at 6.8 percent, but loan loss provisioning is close to 100 percent. Deposits have continued to grow but at a slower pace than before. Banks’ large exposure to government securities is a potential vulnerability, and banks reportedly also have a small net open foreign exchange position.

Program Objectives and Policies

11. The authorities’ new program, supported by the proposed EFF arrangement, aims at addressing macroeconomic vulnerabilities and promoting inclusive growth and job creation. The program is based on four pillars:

  • A significant policy adjustment to restore confidence in and credibility of domestic policies. This envisages: 1) unifying the foreign exchange market under the new floating exchange rate regime to eliminate FX shortages and overvaluation of the pound, and to encourage investments and exports; 2) implementing prudently tight monetary policy to keep inflation contained and bring it down to single digits, and to facilitate build-up of international reserves; and 3) pursuing strong fiscal consolidation to ensure public debt sustainability.

  • Strengthening social safety nets by spending an additional 1 percent of GDP on food subsidies and cash transfers to the poor.

  • Far-reaching structural reforms to promote higher and inclusive growth, job creation, and exports. The authorities intend to focus on improving public finance management, simplifying business regulations, strengthening governance, including in public enterprises, and reforming the energy sector.

  • Fresh external financing to close the financing gaps. The substantial policy adjustment under the program will lead Egypt to a position of fiscal and current account sustainability. Nevertheless, there is still a financing gap of about $35 billion, almost half of which results from the need to rebuild international reserves to the levels that are adequate for preserving macroeconomic stability in the medium term.

A. Macroeconomic Outlook and Risks

12. Medium-term prospects are favorable provided short-term challenges can be addressed and growth-friendly policies and reforms implemented. Inherent strengths of the economy include a dynamic and young population, a large market size, a favorable location, and access to important foreign markets. The opening of the parallel Suez Canal last August, large investments in the energy sector, and the discovery of a major gas field also bode well for Egypt’s medium-term development. However, realizing this potential depends on overcoming near-term challenges such as foreign currency shortages, low policy buffers, and weakened market confidence as well as implementing wide-ranging structural reforms that support inclusive growth. This is a key objective of the authorities’ program

13. The program’s macroeconomic projections are based on the following assumptions:

  • Helped by macroeconomic stabilization, removal of foreign exchange shortages, and the improved business climate, GDP growth is projected to recover to its potential growth of 5–6 percent over the medium term. Depreciation of the pound should make Egyptian goods and services more competitive and the yields on Egyptian assets more attractive. Investment, including FDI, and exports are expected to grow and replace debt-financed consumption as growth engines.

  • Prudent monetary policy is projected to bring inflation down to single digits after one-off effects of depreciation, subsidy reforms, and the introduction of VAT dissipate. The pass-through from the exchange rate to inflation is expected to be limited this year given that a significant part of imports is already priced at the parallel market rate.

  • Fiscal consolidation will be underpinned by improved revenue mobilization, including through the new VAT law and better tax administration, and expenditure optimization through PFM measures, subsidy reductions, and the civil service reform. This should ease pressure on the external sector and place general government debt on a declining path to reach 85.8 percent of GDP by the end of the program and decline further to 78.3 percent of GDP by 2020/21.

  • The current account deficit is expected to narrow to 3 percent of GDP by 2018/19. Export recovery is predicated on exploration of new gas fields and competitiveness gains from real depreciation of the pound and growth-friendly reforms. Import demand will be contained by tighter fiscal and monetary policies, with imports of investment goods financed in part by increasing inflows of FDI. The financial account is projected to benefit from the increased access to international capital markets. The overall BoP surpluses would rebuild international reserves.

  • In 2016/17, output is projected to remain well below its potential. Fiscal consolidation coupled with monetary tightening would inevitably constrain growth. The planned structural reforms will take time to bear fruit. However, elimination of foreign exchange shortages—the single most widely cited impediment to business activities and removal of currency overvaluation should provide a significant boost to production and exports. On balance, real GDP growth is expected to be about 4 percent, broadly the same as in the previous year.

14. The risks to the program are significant and mainly arise from the difficulties inherent in implementing a strong and wide-ranging reform program. Potential fiscal slippages due to revenue shortfalls, higher than programmed wage increases or delays in implementing expenditure measures could undermine the program’s debt sustainability objective, especially in light of persistently high fiscal deficits in the previous several years. Attempts to manage the exchange rate could lead to a loss of reserves or reemergence of a large parallel market premium. Failure to tighten monetary policy sufficiently could lead to strong exchange rate and inflationary pressures and loss of reserves. Opposition by vested interests could derail structural reforms and weaken medium-term growth prospects. These risks are mitigated by the strength of the policies under the program, significant frontloading of major measures, and the program’s backing at the highest political level. The authorities’ commitment to the program was also demonstrated by the implementation of the prior actions.

15. Egypt is also exposed to external shocks. Tighter or more volatile global financial conditions may raise borrowing costs. Lower growth in trade partners (Eurozone, Russia) or a worsening of regional security would hurt trade and tourism. Persistently lower energy prices would reduce remittances and financing from the Gulf countries. On the upside, lower energy prices would help trade and fiscal balances. Egypt’s new flexible exchange regime and prudent macroeconomic policies under the program provide sufficient buffers against these vulnerabilities.

B. Monetary and Exchange Rate Policies

16. On November 3, 2016 the CBE devalued the Egyptian pound by 32.5 percent against the US dollar and allowed the exchange rate to float. In anticipation of the exchange rate move, the parallel market premium exceeded 50 percent at end-October. On November 1 and 2, however, the pound rebounded somewhat in the parallel market, suggesting that the prior rapid depreciation was in part reflective of overshooting. The CBE took advantage of this opportune timing and devalued the official exchange rate to EGP/$13. At the same time, it removed restrictions on setting own buy and sell rates by banks, eliminated the priority import list, and allowed the exchange rate to be market-determined. The CBE’s subsequent foreign exchange auction of $100 million produced a weighted average exchange rate of EGP/$ 14.645. On November 6 buy and sell rates were quoted at 15.7/16.3 per U.S. dollar.

A01ufig1

Exchange Rate

(Egyptian pounds per $)

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

17. In response to mounting inflationary pressures and in conjunction with the float, monetary policy was preemptively tightened. On November 3 the CBE raised policy rates by 300 basis points, and sterilized part of the large liquidity surplus that had built up in the system due to the prior accommodative stance by introducing deposit auctions with maturities of 118 days. At the first such auction the CBE auctioned EGP50 billion and accepted EGP38.8 billion at an average interest rate of 17.5 percent. The CBE and the MOF signed a protocol on limiting direct CBE financing of the budget through overdrafts to prevent injection of new liquidity.

Prospects for Medium-Term Growth

During the last years, Egypt’s growth suffered from worsening fiscal and external imbalances which added to the long-term structural constraints of high unemployment, low labor force participation and an unfavorable business environment. Growth fell to 2.7 percent on average in 2011–2016, sustained by domestic consumption, which resulted in a widening fiscal deficit. The external sector deteriorated sharply, in a context of low investment, a less favorable global environment and security concerns.

The authorities’ program, supported by the three-year EFF arrangement, addresses macroeconomic and structural constraints. With a sound implementation of planned policies, Egypt’s growth could rise to 6 percent over the medium term, which would be comparable to the period 2005–2010 when annual growth averaged 5.9 percent.

On the demand side, growth will be driven by higher investment and improvement of the net external sector. Fiscal consolidation and reforms to improve business climate will help promote private sector development by crowding in private sector’s access to finance and by removing constraints to starting and doing business. Better macro-economic stability will improve market confidence and attract foreign investment, in particular FDI. Greater exchange rate flexibility will strengthen external competitiveness and support exports. The energy subsidy reform will remove the bias towards energy and capital-intensive industries.

It will encourage investment in labor-intensive activities and foster job creation to absorb Egypt’s growing labor force. The energy subsidy reform will also allow the authorities to increase growth-enhancing investments and spending in social sectors (notably health and education).

A01ufig2

Contributions to GDP growth

(percent)

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

On the supply side, manufacturing is projected to recover, while construction and services will remain buoyant. A unified and better functioning foreign exchange market and a gradual increase in Egypt’s electricity production resulting from investments since 2014/15 will remove two major constraints that weighted on manufacturing activity in recent years. Construction and services should continue to expand at dynamic rates while new opportunities such as recently discovered gas fields and the enlarged Suez Canal could also boost medium-term growth.

Lower than projected medium-term growth would have important implications for medium-term public debt sustainability. Under the baseline forecasts, the interest rate-growth differential and improved primary balances will reduce public debt to below 80 percent by 2020/21. Debt projections are particularly sensitive to growth assumptions, and slower GDP growth could weigh significantly on debt sustainability (Annex I). In this context, implementation of the fiscal consolidation plan and the structural reform agenda is important in containing this risk.

18. In the medium term monetary policy will focus on bringing inflation down to mid-single digits. The depreciation, VAT, and the energy subsidy reform are estimated to contribute to average inflation rising to 18 percent in 2016/17. The CBE will accommodate these first-round effects, but will maintain adequately tight monetary policy to contain secondary pressures and reduce inflation to single digits in the next three years. To signal its policy intentions and anchor inflation expectations, the CBE will maintain short-term interest rates at levels that ensure tight liquidity conditions. This will contain domestic demand and allow commercial banks and the CBE rebuild their foreign assets that have been depleted. In 2017/18 and beyond, as inflation declines interest rates will also come down to permit credit recovery. However, the CBE will be prepared to tighten the monetary stance again should demand pressures reemerge.

19. Monetary policy will rely on money targeting. The program sets a tight reserve money path for 2016/17, which will be achieved by controlling credit to government and banks. This will require improved liquidity forecasting and management, and strengthening of CBE independence by removal of fiscal dominance. The Ministry of Finance (MoF) and the CBE have agreed to bring budget overdrafts below EGP75 billion in 2016/17 by securitizing about EGP250 billion and minimizing new issuances. The CBE will closely monitor banks’ excess reserves and rely primarily on indirect policy tools, such as deposit auctions and repo/reverse repo transactions, to achieve its targets, but if warranted may also change reserve requirements. In the process, it will ensure that solvent and viable banks retain access to liquidity to operate uninterrupted.

20. The authorities plan to maintain a flexible exchange rate regime and accumulate significant international reserves. These will serve as buffers against external shocks, strengthen credibility of the CBE, and preserve competitiveness. The program targets the accumulation of about $5 billion in 2016/17, which would raise reserves to above 100 percent of the ARA metric for floating regimes. By the end of the program, gross international reserves are expected to reach almost $33 billion, equivalent to 5 months of prospective imports of goods and services. Once the market regains confidence and the supply of foreign exchange increases the CBE will operate mainly on the buy-side, but occasional FX sales might still be needed to prevent excessive short-term exchange rate fluctuations. The CBE is committed to meeting its program objectives, and will consult the Fund on the needed policy adjustments in the event of excessive FX sales (including direct sales to SOEs and the government).

21. The authorities are committed to eliminate the multiple currency practice (MCP), which has been kept in place not for the BoP purposes. The multiple price currency auctions, which give rise to the MCP, will help develop a well-functioning FX market. The authorities have requested temporary approval of this measure given that that it does not discriminate against other members, does not harm the interests of other members, does not impede the member’s balance of payment adjustment, and is temporary.3 The MCP will be eliminated once the interbank market is well developed. The current limit of $100,000 on transfers abroad by individuals without an underlying commercial transaction and a cap of $50,000 on cash deposits for importing non-priority goods will also be lifted by June 30, 2017. With the unification of the exchange rate, the large parallel market premium is expected to disappear. However, it will take time to assess whether the policy has succeeded. A full analysis of the exchange system will be conducted by the staff prior to the first review to verify Egypt’s compliance with Article VIII.

22. The CBE will strengthen its operations and transparency. Specifically, it will bring its investment regulations for reserve management in conformity with best international practices to ensure that reserves are invested in low risk and highly liquid instruments. Reserve allocation to foreign subsidiaries and branches of Egyptian banks will be capped at the current stock of $5.6 billion. The CBE will develop a new communications strategy to better inform the markets of its policy objectives and to explain its actions. This will include publishing of the financial stability reports (from December 2016) and quarterly reports on monetary policy and inflation (from March 2017), and engaging with media more actively.

C. Fiscal Policy and Public Finance Management

23. Fiscal policy will be anchored to restoring debt sustainability and setting public debt on a clearly declining path. Staff and the authorities shared the view that under unchanged policies public debt would have become unsustainable. The program was designed to balance the debt stabilization objective with the political and economic feasibility of fiscal consolidation. Therefore, the program targets a fiscal consolidation path, which the authorities view as politically feasible and aims at reducing general government debt from 95 percent of GDP in 2015/16 to 86 percent of GDP in 2018/19, and further to 78 percent of GDP by 2020/21. The debt sustainability analysis (Annex 3) shows that under the proposed adjustment scenario public debt is sustainable, though not with a high probability.

24. Consistent with the debt objective, the program targets an adjustment in the primary balance of 5½ percent of GDP over three years. The mission and the authorities discussed whether more ambitious fiscal consolidation would have been appropriate, but the program adjustment is large compared to peers and significant additional adjustment would not be advisable due to its contractionary impact and potentially negative social implications. The primary balance rather than the overall balance is targeted because it better reflects the government’s policy stance by excluding interest payments which are difficult to control given the uncertainty about interest rates during the transition. The overall deficit is also expected to fall during the program from 12.1 percent of GDP to 4.7 percent. Tax revenues are projected to increase by 2.5 percent of GDP during the program mainly because of VAT, which was passed by Parliament in August, and primary expenditure is projected to decline by 3.5 percent of GDP owing to the reductions in wages and subsidies. As public debt declines with the fiscal consolidation, so does the interest bill. This will free up fiscal space for higher spending in the authorities’ priority areas of health, education, R&D, investment and social protection.

25. The 2016/17 budget was approved by Parliament in late June and is consistent with the program objectives. It targets the primary deficit of 0.8 percent of GDP, which corresponds to fiscal consolidation of 2.6 percent of GDP. The new VAT, which was passed by Parliament on August 29, will be introduced at a rate of 13 percent in 2016/17 (compared to 10 percent for the previous General Sales Tax), to be increased to 14 percent in 2017/18. There are exemptions for most staple foods consumed by the poor. The higher tax rate, combined with base broadening and improved compliance, will yield an additional 1 percent of GDP in 2016/17 compared to the GST. On the expenditure side, the elimination in the budget law of indexation of public sector employees’ bonuses and allowances will contain the wage bill increase to below the projected inflation, and generate 0.9 percent of GDP in fiscal savings. The projected net reduction in public employment through the new strict hiring rules, and the streamlined public employment framework under the new Civil Service Law adopted by Parliament in October, are expected to yield additional medium-term savings. Energy subsidies are budgeted to decline by 0.4 percent of GDP in 2016/17 (see ¶27).

26. The authorities’ program has a strong social spending component. To ease the adjustment process, about 1 percent of GDP in fiscal savings will be directed to additional food subsidies, cash transfers to the elderly and the poor families, and other targeted social programs. The aim is to replace poorly targeted energy subsidies with programs that directly support poor households. In addition, resources for programs protecting vulnerable groups, including school meals, subsidies for infant milk and children’s medicines, and vocational training for young people will be preserved or increased.

27. Energy subsidy reforms that begun in 2014 are continuing. The current subsidy scheme is not well targeted and benefits the well-off disproportionately rather than the poor. The staff considers that significant reductions in fuel subsidies during the program are essential. The authorities raised electricity tariffs by about 40 percent in July 2016. Gasoline and diesel prices have been increased on November 3 by 35 percent on average to achieve a pre-tax cost-recovery ratio of 56 percent and the budgeted reduction in the fuel subsidy bill. The authorities are prepared to further adjust fuel prices or take other measures as needed to offset any additional costs in the event of larger than projected depreciation of the pound or higher global oil prices. They have also committed to periodically increasing the pre-tax cost recovery ratio further on most fuel products to achieve 100 percent in 2018/19 and to eliminate electricity subsidies over the next five years.

28. The mission and the authorities discussed safeguards against fiscal slippages. Lower economic growth, higher interest rates, weaker than anticipated VAT performance, wage bill overruns and obligations to non-performing state-owned enterprises were identified as the main risks to the fiscal consolidation. To preserve the fiscal targets, the authorities will consider better targeting of food subsidies by improving the current smart card system; accelerating energy subsidy reforms; revisiting tax exemptions and other tax expenditures; and further cutting non-priority expenditures, as needed.

29. Egypt’s PFM reforms are aimed at strengthening the budgetary framework and improving monitoring of fiscal risks. As key measures, the authorities will: 1) review the classification of the economic authorities in fiscal accounts to identify those that serve public policy objectives and incorporate them in the state budget; 2) in view of potentially significant exposure to contingent liabilities, strengthen the framework that governs the issuance and monitoring of state guarantees and prepare by January 31, 2017 a report on all outstanding state guarantees; 3) develop by June 2017 a road map for pension reforms, including a plan to address the implicit liabilities of the budget sector to the Social Insurance Fund; 4) introduce a medium-term budgeting framework with multi-year rolling ceilings for major spending categories with greater emphasis on programmatic budgeting; 5) prepare and present to Parliament a pre-budget statement on economic and public finance developments; and 6) develop by March 31, 2017 a fiscal risks statements covering macroeconomic risks, public enterprises, debt management, contingent liabilities, pensions, and resource mobilization.

Egypt: Fiscal Measures*

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Measures show the difference between the program values and baseline “zero policy change” estimates by the authorities. Measures may exceed savings relative to 2015/16 due to increases in baseline costs.

D. Energy Sector Reforms

30. In addition to reducing subsidies, the Egyptian authorities are developing a comprehensive reform agenda for the energy sector (petroleum, electricity and gas). The objective is to modernize the sector, including by improving the regulatory framework for enabling private investments, strengthening its finances, and promoting competition. This is particularly important in light of the ongoing development of new gas fields in the Nile delta and the Mediterranean. To this end the Ministry of Petroleum has retained an external consultant to conduct a diagnostic study. On the basis of this, by March 31, 2017 the authorities will develop a medium-term strategy for the energy sector reform.

31. An integrated plan for restoring the financial sustainability of the state-owned Egyptian General Petroleum Company (EGPC) will be finalized by March 31, 2017. EGPC’s finances have deteriorated considerably since 2011, partly because of lower revenues but also because of growing operating costs. This has led to accumulation of $3.6 billion in arrears to international oil companies, who are the main suppliers of fuel, and if left unaddressed could impose significant fiscal burden. The EGPC modernization plan will incorporate the fuel subsidy reform, measures to improve efficiency, transparency and accountability of its operations, and a strategy to deal with the existing stock of arrears. Meanwhile, the EGPC will gradually reduce existing arrears and not accumulate new net arrears.

E. Financial Stability

32. The authorities are confident that the banking system can weather the transition to the new exchange regime. The CBE has conducted extensive stress tests prior to the devaluation to confirm that banks’ capital and liquidity buffers were adequate to withstand devaluation and higher interest rates. The results of stress tests indicated that the banking system would remain sound, but also showed that in the event of a severe shock the capital adequacy ratio of a few small banks could fall below the Basel-recommended 10.5 percent. The implication of depreciation on banks’ credit risk is expected to be moderate in light of relatively small dollarization of balance sheets of corporates and households. However, in the absence of sufficiently detailed bank data for stress tests, the staff cannot assess fully the risks to banks that could arise from a combination of currency depreciation and higher market interest rates. The CBE will monitor developments in banks carefully during the adjustment process, share banks’ financial data with the Fund staff in the coming months and work closely with it to assess health of the banking sector and perform bank-by-bank stress tests as needed to mitigate any risks that may emerge. In this regard, the CBE’s recent request for Fund technical assistance on stress testing is encouraging.

33. The authorities are planning to further strengthen Egypt’s regulatory framework and the crisis response capacity. The CBE is reviewing its supervisory model with the view to implementing best international practices in line with Basel III principles, enhancing transparency, and promoting competition among banks. It is also planning to strengthen its capacity to monitor systemic risks, develop more sophisticated methods for stress-testing and early warning systems, and enhance governance, bank resolution, and emergency liquidity assistance frameworks.

F. Structural Reforms for Growth and Employment

34. There are long-standing challenges of high unemployment and structural impediments to growth. Unemployment has declined marginally in 2015/16, but at 12.7 percent remains high and is significantly higher for youth and women. Furthermore, historically labor force participation has been low by international standards and employment intensity of growth has been too weak to absorb Egypt’s young and growing population. Egypt ranks 122 out of 190 in the World Bank’s Doing Business Indicators, and excessive regulations and licensing requirements, barriers to trade, rigid labor markets, and lack of access to finance are among key structural impediments to growth, exports and employment that have been widely cited by businesses and external observers. They deter investment and depress potential output.

35. In its program, the government has proposed an ambitious and wide ranging set of measures. The government is planning a new licensing law, to be adopted by March 2017, which will: streamline industrial licensing for all businesses other than those serving vital public interests; make factory permitting risk-based and delegate the function to local authorities; and simplify and limit the need for Civil Defense and Fire pre-approvals. This will reduce the complexity and time needed to obtain industrial licenses, which have been identified as key impediments to the development of the sector. The government is also proposing a new insolvency law, to be adopted by June 30, 2017, to simplify the time-consuming bankruptcy procedures and to de-criminalize insolvency. Further, the government will develop: a collateral registry to facilitate access to finance, which is among top complaints of SMEs; an action plan to rationalize the export-promotion regime and minimize non-tariff barriers to trade; and job intermediation schemes and specialized training programs for youth. It will also support women’s labor force participation by spending about EGP250 million on improving the availability of public nurseries, and by studying how to improve the safety of public transportation.

Program Issues

36. The access under the three-year EFF arrangement is proposed at SDR8.59657 billion (about $12 billion, or 422 percent of quota). With the policies outlined in the MEFP, staff projects the financing gaps of about $35 billion for the next three years. Staff proposes that access be evenly distributed over the three fiscal years, but be frontloaded within the first year with a disbursement of SDR 1.97005 billion (about $2.75 billion) on program approval. The proposed schedule of reviews and the corresponding disbursements are presented in Table 13. Given Egypt’s limited access to international capital markets, the authorities request that Fund disbursements be used for budget support, which will help rebalance financing from domestic to foreign sources and thereby reduce fiscal pressure on the private sector. By the end of the program, the overall fiscal deficit is projected to be less than half of its 2015/16 level, and Egypt should be able to meet its financing needs through domestic and external borrowing without resorting to Fund budget support.

Table 1.

Egypt: Selected Macroeconomic Indicators, 2011/12–2016/171/

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Sources: Egyptian authorities; and IMF staff estimates and projections.

Fiscal year ends June 30.

General government includes the budget sector, the National Investment Bank (NIB), and social insurance funds.

Budget sector comprises central government, local governments, and some public corporations.

Includes multilateral and bilateral public sector borrowing, private borrowing and prospective financing (in 2011/12).

Debt at remaining maturity and stock of foreign holding of T-bills.

Table 2.

Egypt: Balance of Payments, 2011/12–2020/21

(In billions of US$, unless otherwise indicated)

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Sources: Central Bank of Egypt; and IMF staff estimates and projections.

Includes the amortization of official external financing from Gulf Cooperation Council (GCC) countries and EGPC arrears.

In 2010/11 to 2012/13, includes accumulation of EGPC arrears.

EGPC arrears.

Includes multilateral and bilateral public sector borrowing, private borrowing and prospective financing (in 2011/12).

Table 3.

Egypt: Balance of Payments, 2011/12–2020/21

(In percent of GDP, unless otherwise indicated)

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Sources: Central Bank of Egypt; and IMF staff estimates and projections.

Includes the amortization of official external financing from Gulf Cooperation Council (GCC) countries and EGPC arrears.

For FY 2010/11 to FY 2012/13, includes EGPC arrears.

EGPC arrears.

Includes multilateral and bilateral public sector borrowing, private borrowing and prospective financing (in 2011/12).

Table 4.

Egypt: Budget Sector Operations, 2011/12–2020/211/

(In billions of Egyptian pounds, unless otherwise indicated)

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Sources: Ministry of Finance; and IMF staff estimates.

Budget sector comprises central and local governments, and some public corporations. Fiscal year ends June 30. Cash basis.

Food subsidies include subsidies paid to farmers.

The authorities accounted as grants in 2013/14 and 2014/15 the transfer to the budget of special deposits held at the CBE received from abroad following the 1991 Gulf War. Staff recorded these amounts as central bank financing below the line, consistent with GFSM principles.

Oil revenue minus fuel subsidies. Oil revenue includes corporate income tax receipts from EGPC and foreign partners, royalties, extraordinary payments, excise taxes on petrol products, and dividends collected from EGPC.

Includes debt issued to the SIF for settlement of past arrears and implied future liabilities

Table 5.

Egypt: Budget Sector Operations, 2011/12–2020/211/

(In percent of GDP)

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Sources: Ministry of Finance; and IMF staff estimates.

Budget sector comprises central and local governments, and some public corporations. Fiscal year ends June 30. Cash basis.

Food subsidies include subsidies paid to farmers.

The authorities accounted as grants in 2013/14 and 2014/15 the transfer to the budget of special deposits held at the CBE received from abroad following the 1991 Gulf War. Staff recorded these amounts as central bank financing below the line, consistent with GFSM principles.

Oil revenue minus fuel subsidies. Oil revenue includes corporate income tax receipts from EGPC and foreign partners, royalties, extraordinary payments, excise taxes on petrol products, and dividends collected from EGPC.

Includes debt issued to the SIF for settlement of past arrears and implied future liabilities

Table 6.

Egypt: General Government Operations, 2011/12–2020/211/

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Sources: Ministry of Finance; and IMF staff estimates.

General government includes budget sector, National Investment Bank (NIB) and social insurance funds. Fiscal year ends June 30. Cash basis.

Table 7a.

Egypt: Central Bank Accounts, 2011/12–2020/21

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Sources: Central Bank of Egypt; and IMF staff estimates and projections.

Reserve money in 2014/15 was affected by cancellation of deposit renewals at the CBE due to unexpected announcement of national holiday on June 30, 2015.

Table 7b.

Egypt: Monetary Survey, 2011/12–2020/21

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Sources: Central Bank of Egypt; and IMF staff estimates and projections.

Reserve money as of end 2014/15 was affected by cancellation of deposit renuewals at CBE due to unexpected announcement of national holiday on June 30, 2015.

Table 8a.

Egypt: Summary of National Accounts, 2011/12–2020/21

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Sources: Egyptian authorities; and IMF staff estimates and projections.

Contribution to growth.

Components do not sum up to total due to statistical discrepancies associated with changes of base years.

Table 8b.

Egypt: Summary of National Accounts, 2011/12–2020/21

(In percent of GDP)

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Sources: Egyptian authorities; and IMF staff estimates and projections.
Table 9.

Egypt: Medium-Term Macroeconomic Framework, 2011/12–2020/21

(In percent of GDP, unless otherwise indicated)

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Sources: Egyptian authorities; and IMF staff estimates and projections.
Table 10.

Egypt: Financial Soundness Indicators of the Banking System

(End-June, unless otherwise indicated)

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Source: Central Bank of Egypt.
Table 11.

Egypt: Capacity to Repay the Fund, 2013/14–2020/211/ 2/

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Source: IMF staff calculations.

Fiscal year starts on July 1 and ends on June 30.

Assumes repurchases are made on obligations schedule.

Debt service includes interest on the entire debt stock and amortization of medium- and long-term debt.

Quota changed from 943.7 to 2037.1 millions SDRs effective as of February 2016

Table 12.

Egypt: External Financing Requirement and Sources, 2014/15–2020/21

(In billions of US$, unless otherwise indicated)

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Sources: Central Bank of Egypt; and IMF staff estimates and projections.
Table 13.

Egypt: Proposed Schedule of Purchases Under the Extended Arrangement

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Source: IMF staff calculations.

37. Egypt’s capacity to repay the Fund is adequate, but there are significant risks (¶¶14–15). By the end of the arrangement in 2018/19 Fund credit outstanding as a share of gross reserves is projected to peak at 36 percent, after which it is expected to decline. Debt service to the Fund as a ratio of exports of goods and services would reach 0.6 percent in the same year (Table 11). The CBE and MoF have signed a memorandum of understanding on respective responsibilities for servicing the Fund credit to ensure uninterrupted repayments. The safeguards assessment will be completed before the first review.

38. The program will be monitored through semi-annual reviews. The first review will be based on the performance at end-December 2016, which is less than two months after the Board approval. Thereafter, as the macroeconomic situation stabilizes, semiannual reviews should become sufficient, especially given frequent reporting requirements. Risks to the program could also be mitigated through frequent staff visits and re-establishment of a resident representative office in Cairo after the start of the program. It sets performance criteria on net international reserves, net domestic assets of the CBE, the primary fiscal balance, fuel subsidies, and accumulation of external debt payment arrears, and indicative targets on average reserve money, tax revenues, and EGPC arrears (MEFP Table 1). The list of structural benchmarks is presented in MEFP Table 2.

39. The prior actions that were chosen from the authorities’ reform program, have been implemented. The VAT law has been adopted in late August, and pump prices on gasoline and diesel have been raised by 35 percent on average to achieve an average pre-tax price-to-cost ratio of about 56 percent. The CBE devalued the exchange rate by 32.5 percent on November 3, issued a notice to banks allowing them to quote and trade at any exchange rate, raised policy interest rates by 300 basis points and offered EGP50 billion in longer term deposit auctions.

40. The program is fully financed in 2016/17, but additional financing will need to be secured for 2017/18 and 2018/19. With the proposed Fund disbursement schedule, the 2016/17 financing gap narrows to $12.3 billion, for which financing assurances for the first 12-months of the extended arrangement have been secured as follows: $2 billion from the World Bank’s Development Policy Financing ($1 billion was disbursed in early September upon adoption of the VAT law); $0.5 billion from the African Development Bank, $3.2 billion from rolling over loans from Afreximbank, $1 billion from a UAE deposit, $1.35 billion from a repo transaction with international commercial banks, $950 million from the planned issuance of a Eurobond, $2.7 billion from a currency swap with China, $250 million from Germany, $150 million from the U.K. and France each, and $50 million from Japan. In addition, significant project financing is expected from France and Japan. The financing gaps for 2017/18 and 2018/19 are much smaller, and there are good prospects that they can be covered with multilateral support, rollovers of some maturing liabilities, and little fresh financing.

Staff Appraisal

41. Egypt is facing three interlinked problems: an urgent balance of payments problem, rising public debt, and the long-standing issue of low growth and high unemployment. The balance of payments difficulties have been manifested in a high current account deficit, falling reserves, the emergence of a parallel exchange market, and foreign currency shortages. These have affected every aspect of life in Egypt, holding back growth and leading to scarcity of essential items. Rising public debt is a consequence of years of double-digit fiscal deficits, themselves a reasonable response to the post-revolution difficulties of the real economy, but now a luxury that Egypt cannot afford. Both actual and potential growth have fallen in recent years, leading to rising unemployment, which is especially high among women and young people.

42. The program aims to solve all three problems. Exchange rate depreciation and greater flexibility will improve the balance of payments, sustaining reserves and reducing vulnerability. It will also promote exports, thus increasing growth. The budget measures will reduce the deficit and put debt on a clearly declining path, while supporting the external adjustment. The key measures are the newly passed VAT and the resumption of fuel subsidies reform. Together these make it possible to reduce the deficit and strengthen social safety nets to protect the poor and vulnerable groups during the adjustment. Monetary policy will be geared to containing and then reducing inflation. Structural reforms that improve the business environment will raise potential growth and create jobs. Reforms designed to improve access to education and women’s ability to participate in the work force will make growth more inclusive.

43. The program is a break with the past in many important respects. The exchange rate move recognizes that attempting to preserve an overvalued rate is unsustainable. Subsidies reform removes a preference for energy and capital intensive industries to make room for smaller and more labor-intensive businesses to grow. Civil service reform is designed to reverse the upward creep of the wage bill. The program also constitutes a transformation in the relationship between Egypt and the Fund, with the authorities committing to measures that the Fund can fully support, and the Fund supporting a home-grown program.

44. Risks to the program are significant and much work remains to be done to ensure its successful implementation. The CBE may come under pressure to limit exchange rate flexibility and it will be crucial to stay committed to program policies and targets. Exchange rate liberalization will take time to bear fruit and there will be volatility and uncertainty along the way. There will be pressures to weaken fiscal policy, which must be resisted if inflation and public debt are to be contained. Subsidies reform is both essential and difficult. The fuel price increases made by the authorities in November 2016 were significant, yet are barely enough to raise the price to cost ratio, given increases in world oil prices and the recent depreciation of the pound. The implemented increase, together with the authorities’ commitment, provide a reassurance that the program objectives of increasing efficiency and reducing the fiscal burden can be achieved. Further significant increases in energy prices will be needed to achieve the authorities’ goal of eliminating most subsidies in the coming years. Structural reform will take years, and may be at risk of erosion from vested interests. Resolute implementation of the program will be critical to rebuild international reserves, unify the foreign exchange market, and strengthen debt sustainability. Reform efforts will need to be stepped up to restore confidence and fully realize Egypt’s growth potential.

45. There are also external risks. Egypt’s own security has been vulnerable to terrorism, and it is not immune from the crises of its neighbors. As Egypt re-engages with international financial markets global financial risks will matter more. As trade and tourism pick up, the performance of its trading partners will also be important.

46. Financial support from Egypt’s international partners is a critical element of this program. The World Bank and the African Development Bank are strong partners in the process. Timely and generous support from China, UAE and the G7 countries have made it possible to close the financing gap and bring this program to the Board. Fresh financing and rollover of debts falling due will be needed in the outer years of the program, though the need for such support will taper off by the end of the program period.

47. This program is also an opportunity. With the enaction of the measures in this program, Egypt is moving in a new economic direction consistent with its important role in the Arab world and with the aspirations of a new generation of Egyptians who look outward. The restoration of macroeconomic stability will allow Egypt to put the economic turbulence of the post-revolution period behind it. Undertaking fundamental reforms of the exchange rate policy, fuel subsidies, the business climate, and the blockages which prevent vulnerable groups from engaging in the economy will also allow Egypt to address the problems of non-inclusive growth and economic inclusivity. The staff supports the authorities’ request for a three-year EFF arrangement and the authorities’ request for temporary approval of the measure that gives rise to an MCP on the grounds that it does not discriminate against other members, does not harm the interest of other members, does not impede the member’s balance of payment adjustment, and is temporary.

Figure 1.
Figure 1.

Egypt: Real Sector Developments

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

Sources: Egyptian authorities; IMF, International Financial Statistics; Bloomberg; Markit Economics; and IMF staff calculations and projections.
Figure 2.
Figure 2.

Egypt: Fiscal Sector Developments

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

Sources: Egyptian authorities; IMF, International Financial Statistics; Bloomberg; and IMF staff calculations and projections.
Figure 3.
Figure 3.

Egypt: External Sector Developments

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

Sources: Egyptian authorities; IMF, International Financial Statistics; Bloomberg; and IMF staff calculations and projections.
Figure 4.
Figure 4.

Egypt: Monetary Sector Developments

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

Sources: Egyptian authorities; International Financial Statistics; Bloomberg; and IMF staff calculations and projections.

Annex I. Public Debt Sustainability Analysis

Egypt’s public debt is sustainable, but not with high probability. The baseline scenario assumes a considerable adjustment program, which is projected to result in debt falling from 94 percent of GDP in 2015/16 to 76 percent of GDP in 2020/21. Debt dynamics and financing needs under the stress testing scenarios show significant macro-economic risks, especially in terms of growth and contingent liability shocks. A large captive domestic investor base, and moderate external debt levels represent important mitigating factors. The DSA has been shared with the authorities, and they are broadly in agreement with its findings.

1. The baseline scenario assumes a considerable adjustment program. This is underpinned by the following assumptions:

  • Real GDP growth of 4 percent is expected in 2016/17. Growth is forecast to gradually increase to around 5–6 percent over the medium term as investment and exports replace debt financed consumption as growth engines. The investment boost is based on public investment in social and economic infrastructure, large investments in the energy sector, and the discovery of a major gas field.

  • Inflation (defined in this annex as the GDP deflator) is estimated to temporarily increase from around 10 percent in 2015/16 to around 19 percent in 2016/17, but is projected to decline to around 7 percent over the medium term.

  • The primary balance of the general government is projected to switch from deficits to surpluses from 2017/18. These projections are based on the adjustment program that includes considerable revenue and expenditure measures. The following measures on the expenditure side are proposed: (i) controlling the public sector wage bill; (ii) implementing the next phase of energy subsidy reform; and (iii) improving the targeting of social transfers. Revenue measures include: (i) introduction of a VAT at a higher rate than the current GST; (ii) improvements in tax administration; and (iii) ensuring that appropriate dividends are paid to government by profitable public agencies. The Staff Report provides more detailed discussion of the fiscal program.

2. The baseline projections are ambitious, with risks on downside. Egypt’s forecasts for growth, primary balance, and inflation tend to be systematically optimistic, but the projection errors are not very different from the benchmark. The projected fiscal adjustment in the (cyclically-adjusted) primary balance is larger compared to the benchmark countries, but plausible given a higher starting primary deficit. The challenge of measuring the output gap for a country like Egypt that is undergoing a very rapid transition is significant and so the estimates of the (cyclically-adjusted) primary balance should be treated with caution.

3. The improving debt outlook reflects the projected path of fiscal adjustment and favorable interest rate-growth differential. The public debt-to-GDP ratio is forecast to decrease from 94 percent in 2015/16 to 76 percent in 2020/21. The fiscal consolidation strategy, measured by changes in the primary balance, is relatively ambitious, with significant front-loading in 2016/17. Economic growth, accompanied by favorable interest rate dynamics, will be the main factor contributing to debt reduction over time. The gross financing needs-to-GDP ratio is forecast to gradually decline over the projection period.

4. Projections of debt and financing needs are particularly sensitive to growth and contingent liability shocks:

  • Growth shock. Slower growth is the principal risk to debt sustainability. Assuming a decline in growth by one standard deviation for 2016/17 and 2017/18, the debt-to-GDP ratio is forecast to reach 96.4 percent in 2017/18 and to fall to 83 percent in 2020/21. Extending the growth shock to 2020/21 yields a debt forecast of 90 percent of GDP.

  • Macro-fiscal shock. Considering a stress scenario in which shocks to growth, interest rate, and primary balance occurred simultaneously, the debt-to-GDP ratio would reach 101 percent by 2017/18, with subsequent decline to around 90 percent.

  • Contingent liability shock. In the absence of concrete estimates of contingent liabilities, a standardized shock of 10 percent of banking assets is used to represent a hypothetical realization of such contingent liabilities. In such a scenario, the debt-to-GDP ratio would exceed 100 percent in 2017/18 and decline to 86 percent in 2020/21.

5. The fan charts show significant uncertainty around the baseline. The width of the symmetric fan chart (around 25 percent of GDP) illustrates the uncertainty for equal-probability upside and downside shocks. However, in light of the downside risks associated with the adjustment program implementation challenges, the asymmetric fan chart constrains upside shocks to growth and primary balance to zero, resulting in a less downward-sloping debt path. This reflects a balance of risks skewed to the downside.

6. Egypt’s debt profile is relatively benign, although external market pressures have increased. Public debt in foreign currency and held by non-residents is below the lower risk-assessment benchmark. External financing needs are slightly above the lower risk-assessment benchmark. The sovereign spreads are however now slightly above the upper risk-assessment benchmark, indicating that the risk perception of the international capital market participants has increased.

7. Risks to debt sustainability need to be weighed against mitigating factors.

  • Investor base. Debt is held largely by domestic financial institutions, with an external component of about 8 percent of total debt. This factor, coupled with relatively low demand for private sector credit and limited regional investment opportunities, has resulted in a captive investor base. In addition, a significant share of domestic debt is held by the CBE.

  • Buffers. There are also significant cash cushions in the form of deposits accumulated by the general government, mostly in local authorities. The average figure for government deposits is around 10 percent of GDP, implying a markedly lower public debt-to-GDP ratio on a net basis and some liquidity cushion in terms of coverage of financing needs for few months.

A01ufig3

Egypt Public DSA Risk Assessment

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are:200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ Long-term bond spread over U.S. bonds, an average over the last 3 months, 30-Dec-15 through 29-Mar-16.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
A01ufig4

Egypt Public DSA - Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

Source: IMF Staff.1/ Plotted distribution includes program countries, percentile rank refers to all countries.2/ Projections made in the sprinq WEO vintaqe of the precedinq year.3/ Not applicable for Eqypt, as it meets neither the positive output qap criterion nor the private credit qrowth criterion.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerqinq economies with debt qreater than 60 percent of GDP. Percent of sample on vertical axis.
A01ufig5

Egypt Public DSA - Stress Tests

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

Source: IMF staff.
A01ufig6

Egypt Public DSA - Stress Tests

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

Source: IMF staff.
A01ufig7

Egypt Public DSA - Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

Source: IMF staff.

Annex II. External Debt Sustainability

Egypt: External Debt Sustainability Framework, 2011–2021

(In percent of GDP, otherwise indicated)

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Derived as [r - g - r(1+g) + ea(1+r)]/(1+g + r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

A01ufig8

Egypt: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2017, 017; 10.5089/9781475566901.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2010.

Appendix I. Letter of Intent

November 7, 2016

Ms. Christine Lagarde

Managing Director

International Monetary Fund

Washington, D.C.

Dear Ms. Lagarde:

Egypt is in the midst of a historic transition. The political process has advanced steadily, with the adoption of a new constitution and a presidential election in 2014 and the election of a new parliament in December 2015. However, the long political transition after the revolution of 2011, made worse by heightened security concerns in the region, have taken a toll on confidence and investment, and led to acute balance of payments challenges. While Egypt’s medium and long term economic prospects are favorable supported by its strategic location, tourism potential, natural gas reserves, abundant investment opportunities, and young and growing labor force, short-term vulnerabilities have increased. The multiple shocks and prolonged uncertainty triggered capital outflows while investment and tourism declined. The difficult global financial and economic environment and volatile commodity prices have further complicated the situation. As a consequence, growth and job creation remained below potential, the government’s budget came under significant pressure, exports declined, inflation picked up, and foreign exchange shortages emerged.

To address the policy challenges facing the Egyptian economy, we have developed a comprehensive macroeconomic program as laid out in the attached Memorandum of Economic and Financial Policies (MEFP). Most of the pillars and measures of our program were announced by the government and were presented and endorsed by the parliament ahead of discussions held with the IMF. To support our efforts, we request a three-year extended arrangement under the IMF’s Extended Fund Facility in the amount equivalent to SDR 8.59657 billion (422 percent of quota and about $12 billion). Our international partners have committed adequate additional funds to help ensure that the proposed program is fully financed.

Our program consists of front-loaded policy adjustment and structural reforms aimed at achieving and maintaining macroeconomic stability, promoting inclusive growth and employment creation, supporting private sector development, and protecting vulnerable groups. It seeks to bolster market confidence by reducing the fiscal and external imbalances, addressing structural impediments to growth, and fostering human and infrastructure development. To this end, we have already adopted the flexible exchange rate regime as a buffer against external shocks that ensures a market clearing level. To support smooth transition to a more flexible exchange rate regime over the coming months, we request temporary approval of the identified multiple currency practice. Fiscal policy will focus on narrowing the budget deficit to set the public debt on a clearly downward path over the medium-term, while creating space for priority spending on public infrastructure, poverty alleviation, health, education, and social transfers. Monetary policy will seek to control and gradually reduce inflation, support credit growth, maintain an orderly foreign exchange market, and increase in international reserves. Financial sector policies will be geared toward safeguarding the strength and stability of the banking system, and structural reforms will aim at improving the business environment, supporting the export sector, deepening labor markets, simplifying regulations and promoting competition including through IPO sales for some public enterprises. Public financial management and fiscal transparency will be strengthened to improve governance and delivery of public services, and enhance accountability in policymaking.

In line with Fund’s policy, a safeguards assessment is expected to be completed by the time of the first program review. IMF resources that will be used for budget support will be maintained in government accounts at the Central Bank of Egypt (CBE). The CBE and the Ministry of Finance will sign a memorandum of understanding that clarifies the responsibilities related to this agreement.

We believe that the policies described in the attached MEFP are adequate to achieve the objectives of our program over the medium-term. We will monitor economic developments and performance and we stand ready to take additional measures that may become necessary to achieve our program objectives. In accordance with the Fund’s policies, we will consult with the IMF on adoption of these measures and in advance of revisions to policies contained in the MEFP. We will supply the Fund with timely and accurate data that are needed for program monitoring. Program reviews will be semi-annual. The first review is expected to be completed on or after March 15, 2017 and the second review will be completed on or after November 11, 2017. We consent to the publication of this letter, the MEFP including Tables 1 and 2, the TMU and the related staff report.

Sincerely yours,

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Attachments (2)

Attachment I. Memorandum of Economic and Financial Policies

A. Introduction

1. Egypt is facing significant economic and financial challenges. Political instability during 2011-14 and elevated security concerns in the region have taken significant toll on the Egyptian economy and intensified the long-standing issues of inadequate growth and high unemployment. The uncertainty has hurt business confidence, reduced investments inflows into the country, raised risks, and led to a considerable slowdown in leading economic sectors. Unemployment remains high, while uneven and low to moderate growth has been insufficient to absorb rapidly growing labor force.

2. The current economic situation calls for resolute measures to maintain macroeconomic stability and remove distortions. The past five years have demonstrated that the exchange rate regime, foreign currency restrictions, high budget deficits, and administered pricing, especially in the energy sector, constrain competitiveness of the Egyptian economy. A challenging business climate, weak public finances, and structural obstacles further limit growth potential and reduce room for policy maneuver. To address the multiple challenges facing our country, we are putting in place a comprehensive and balanced program of policy adjustment, structural reforms and financing. We intend to fully utilize our internal resources and international support to transform Egypt into a dynamic, productive and fast-growing economy. Inclusive, broad-based growth and job creation will be essential to generate incomes and strengthen wellbeing of all Egyptians.

B. Recent Economic Development

3. Following a favorable 2014/15, the pace of economic growth slowed in 2015/16 and inflation increased. Tourism arrivals declined by about 63.9 percent in between October 2015 and June 2016, and improved to negative 41.8 percent in July 2016. The manufacturing sector weakened due to shortages of foreign exchange and to a lesser extent few incidents of irregular energy supply. Although construction, the public sector, retail trade and some services remained buoyant, overall real growth for the fiscal year is estimated to remain below potential mainly due to a contraction in the tourism sector by an estimated 25 percent. While CPI inflation averaged 10.1 percent in 2015/16 compared to 11 percent a year ago, the end-of-period CPI inflation increased to 14.1 percent in September 2016, and core inflation (excluding certain food items and regulated prices) rose from 8 percent in 2014/15 to 13.9 percent in September 2016. Inflationary pressures primarily stemmed from food prices, but supply bottlenecks, strong domestic consumption and pass-through from the exchange rate and adjustments in some regulated prices also played a role.

4. The external position also weakened in 2015/16. The current account deficit widened to 5.5 percent of GDP from 3.7 percent in 2014/15. Although imports of goods and services fell by 2.5 percent of GDP, largely because of shortages of foreign exchange and weak growth in addition to the fall in oil and commodity prices, the balance of goods and services worsened as exports contracted even more than imports by 3.1 percent of GDP. Tourism receipts fell by about $3.6 billion, or 1.1 percent of GDP. At the same time, official grants and private remittances also fell, partly reflecting the unfavorable global environment and deteriorating incomes of the Egyptian migrants in Gulf countries due to low oil prices. Gross international reserves declined by about $2.5 billion from 3.6 months of prospective imports in 2014/15 to 3.1 months in 2015/16.

5. The overall fiscal deficit of the budget sector increased from 11.5 percent of GDP in 2014/15 to 12.1 percent in 2015/16, which is significantly larger than the budgeted 8.9 percent of GDP. Because of the delays in implementing some of the main planned reforms including the VAT, postponement of the capital gains tax, the unification of income tax rates and slowdown in economic activities, revenues fell short of expectations. General government gross debt increased to an estimated 94.6 percent of GDP.

6. We have taken a number of steps toward liberalizing the exchange rate regime as necessary to address bottlenecks in the foreign exchange market. On November 3 we have adopted a flexible exchange rate regime as a buffer against external shocks that ensures a market clearing level (prior action). Banks have been allowed to buy and sell FX at their own rates and the priority imports lists have been eliminated. The CBE has also communicated to the market that it will only participate in trading sessions sporadically to minimize disorderly exchange rate movements. The change of the exchange regime was accompanied by a significant tightening of monetary policy by raising policy rates by 300 basis points and removing EGP38.8 billion of the liquidity surplus from the banking system via the newly introduced deposit auctions of 118-day maturities. This was a critical step to minimize overshooting and avoid disorderly adjustment in the foreign exchange market.

C. Economic Program

7. We have developed a comprehensive reform program that will address the current macro imbalances and the deep seated problems that hold back the Egyptian economy. The key objectives of the program are to restore macroeconomic stability, strengthen fiscal and external sustainability, and lay solid foundation for inclusive and robust growth, and employment creation. We are implementing strong and front-loaded adjustment of fiscal and monetary policies to stabilize the economy and place public debt on a clearly declining path. We have also launched broad-ranging structural reforms to support private sector development, strengthen the financial sector, promote exports, and improve governance and the business climate. We believe our efforts will help restore confidence, attract investments, and continue to catalyze international financial support that is essential to ensure adequate financing of the program.

Monetary and Exchange Policies

8. Monetary policy will seek to control and gradually reduce inflation to single digits over the medium term. This will support real incomes and enhance external competitiveness. In 2016/17 average inflation is projected to increase, primarily due to the supply-side factors such as the recent adjustment of the pound, introduction of the VAT, and the increase in energy prices. While the first-round impact on inflation will be accommodated, the monetary stance will be geared toward containing the second-round effects and preventing demand pressures. We have preemptively tightened the monetary stance before moving to the flexible exchange rate regime and sterilized excess liquidity. Specifically, the CBE raised the policy rate and introduced deposit auctions with longer maturities to lock banks’ excess reserves. As inflation starts to moderate, the CBE envisages a measured easing of the monetary stance to allow a reduction in interest rates and a resumption of credit growth. However, should demand pressures continue to persist, the CBE will stand ready to delay the loosening or even tighten monetary policy as needed.

9. The monetary policy framework during the program period will be based on money targeting. Reserve money will be an indicative target and reflect our projections of market liquidity consistent with the chosen inflation path. We will strengthen our liquidity management and forecasting framework to encompass all segments of the money market, the government securities market, and the foreign exchange market. We will strengthen collaboration between the CBE and the MoF to incorporate public sector flows in the monetary program, and develop capacity for analyzing and forecasting high frequency patterns for fiscal revenues, expenditures, external financing and domestic financing needs. Monetary operations will primarily rely on indirect policy instruments building in particular on the existing deposit auctions and standing facilities, which will enable the CBE to achieve its monetary targets and redistribute liquidity among banks. However, it may also resort to changing reserve requirements as needed whenever liquidity surpluses or shortages are viewed to be structural. To minimize liquidity injection through direct credit to government, by December 31, 2016 we will reduce the current stock of government overdrafts at the CBE by converting EGP250 billion into government securities (structural benchmark) and cap overdrafts thereafter to EGP 75 billion in 2016/17. Any additional holdings of government securities by the CBE will be determined by considerations of monetary policy or to capitalize the central bank should such a need arise. Short-term direct lending to the government will be used only in exceptional situations to bridge to financing from other sources with strict observance of the overdraft limits.

10. We are committed to maintaining a flexible exchange rate regime, while aiming at rebuilding official reserves. With the exchange rate adjustment behind us, the new regime will play a critical role in preserving competitiveness and serve as an important buffer against external shocks. Our goal for gross international reserves is to accumulate about $4.9 billion between June 2016 and June 2017, $7 billion in 2017/18 and an additional $4 billion in 2018/19 to reach 136 percent of the Fund’s reserve adequacy metric for flexible exchange rate regimes. The CBE will continue to supply foreign exchange at market rates to the government for servicing foreign debt and, for a transitional period, to facilitate government payments for critical imports. Supported by coherent policies and renewed confidence in Egypt, we expect private capital inflows to increase, which will allow the CBE to replenish reserves. The CBE will also stand ready to make occasional sales if unusually large short-term flows pose stability risks to the market. These interventions will be done transparently and the objectives will clearly be communicated to the market. Otherwise, the exchange rate will be market-determined in open and transparent trading, for which an adequate infrastructure is already in place If FX sales in auctions or the interbank market are excessive, we will tighten monetary policy by raising policy rates or increasing the volume of deposit auctions, or raising reserve requirement (structural benchmark). We will consult the Fund on the needed policy response if FX sales (including direct sales to SOEs and the government) are excessive.

11. The CBE will strengthen its reserve management practices in line with best international practices. We will develop new investment guidelines for reserve management according to which the CBE will only allocate its reserves in reputable foreign banks and financial instruments. The allocations in banks headquartered in Egypt and located abroad will be limited to $5.6 billion. They will also provide guidance on the currency distribution and exposure limits. The guidelines will encompass a) clear objectives for reserve management; b) a framework for accountability and transparency of reserve management activities and their outcomes; c) sound institutional and governance structures; and d) a prudent risk management framework. The investment guidelines will be approved by the CBE board by December 31, 2016 (structural benchmark).

12. To enhance the effectiveness of monetary and exchange rate policies, the CBE has strengthened its communication strategy. We believe that transparent and frequent communication of monetary policy objectives, the reasons behind policy decisions and the central banks’ assessment of economic developments would help steer market expectations in the right direction and minimize surprises. This strengthens perceptions of stability and contributes to policy credibility. From March 2017 the CBE will regularly publish financial stability reports and will also start publishing quarterly monetary policy and/or inflation reports which will discuss monetary, exchange rate and interest rate developments, the causes of inflation and the measures taken to control it, and will offer the CBE’s views of the outlook, risks to that projection and the policy direction (structural benchmark). When buying or selling foreign exchange in the market, the CBE will also clearly communicate the reasons for its interventions.

13. The CBE will gradually remove the multiple currency practice (MCP) identified by the Fund. An MCP arises from the multiple price auction system established by the CBE, as the exchange rates for spot transactions in an auction may differ by more than two percent. We are requesting temporary approval for this measure. Earlier this year the CBE lifted most of the limits on FX deposits but the restriction on resident individuals to transfer abroad no more than $100,000 annually without an underlying commercial transaction remains in place. Transfers by resident corporations for bona fide current transactions, and by non-residents, are not restricted. Conditional on continued FX market stability, sustained build-up of net international reserves and no pressure in FX cash market, we will remove the $50,000 cash deposit cap for non-priority goods as well as eliminate the restriction on resident individuals to transfer abroad no more than $100,000 without an underlying commercial transaction. We would welcome an assessment of the reformed exchange system by the time of the first program review, and will work closely with Fund staff to eliminate the remaining controls

Fiscal Policy

14. Our fiscal policy is anchored to placing public debt on a clearly declining path toward more sustainable levels. To achieve our goal of strong and inclusive economic growth and to contain inflationary pressures, we are implementing fiscal reforms aimed at balancing between the need to sustainably finance our social programs while also contributing to economic growth and development. Ambitious fiscal consolidation is considered necessary and is planned to reduce debt service costs and free up public funds for high-priority spending, such as infrastructure, health and education, and social protection. This will support lower inflation and higher growth in private sector credit, and allow rebuilding of fiscal buffers to deal with future shocks. Our objective is to reduce general government gross debt from the 94.6 percent of GDP in 2015/16 to about 85.8 percent of GDP by 2018/19 and to 78.2 percent by 2020/21. To this end, we intend to move from the budget sector primary fiscal deficit of 3.4 percent of GDP in 2015/16 to a surplus of 2.1 percent of GDP in 2018/19, and broadly maintain those surpluses through 2020/21. For credibility and faster results, we are frontloading the adjustment—our 2016/17 budget which was approved by Parliament in late June targets a primary deficit of 0.8 percent of GDP. Should external budget support (program disbursements) exceed the programmed levels, we will consider using part of the excess for public investment projects with high rates of social and/or economic returns. In such cases, we will seek modification to the performance criteria on the primary fiscal deficit and net international reserves, consistent with the objectives of the program, in the context of the next program review. As required by the budget law, we will request approval from Parliament of any increases in expenditure under specific headings that are required to implement the program budget.

15. The fiscal consolidation is solidly grounded on number of revenue enhancing and expenditure optimization measures. Specifically,

Revenue measures:

  • VAT reform: In August the Parliament approved the new VAT law (prior action), which became effective as of September 8, 2016 to replace the pre-existing General Sales Tax. The new VAT regime is fairer and more efficient, and considerably expands the taxable base. The new endorsed law stipulates a standard rate of 13 percent in FY 2016/2017 before increasing to 14 percent starting in FY 2017/2018. At 14 percent VAT rate, this reform will generate 1.1-1.3 percent of GDP in additional revenues in 2016/17–2018/19.

  • Small business tax regime: The Parliament also approved by end of August a new simplified tax dispute settlement law. This law will introduce a new simplified and transparent mechanism that should bring an end to many existing disputes with tax payers. This should generate additional revenues in 2016/2017 as well as contribute to improving confidence between the tax authority and tax payers. This will be supplemented before end-March 2017, by the introduction of an effective and simplified tax regime for SMEs where small tax payers will pay a reduced flat tax rate on annual recorded turnover levels.

  • Tax base expansion and administrative reforms: Over the next year, we will closely study the redistributive incidence of tax exemptions with a view to expanding the tax base, improving tax efficiency, and reducing economic distortions. Our aim is to increase revenue by 0.4–0.6 percent of GDP in 2018/19.

  • Capital gains tax or stamp tax: Capital gains tax was introduced in 2014 but was temporarily suspended for listed companies, to be reinstated from May 2017 (structural benchmark). Revenue is likely to be relatively small initially (around 0.1 percent of GDP), but has the potential to grow strongly over the long-term.

  • Tobacco excise: The excise rates on tobacco products were increased. This is projected to generate 0.2 percent of GDP in 2016/17.

  • Other revenue measures: A number of other revenue measures will boost government revenue by an additional 0.3 percent of GDP in 2016/17, increasing to 0.5 percent in 2018/19. These other measures include the sale of telecom licenses and land, fees and licensing, and the return of positive cash balances in government agencies.

Expenditure measures

  • Wage bill: The total wage bill declined from 8.5 percent of GDP in 2013/2014 to 7.6 percent of GDP in 2015/16 and is projected to further decline to 6.7 percent in 2016/17. This projected path is expected to materialize from several sources: a) the new budget law eliminates indexation of bonuses and allowances of public employees and defines them in nominal terms as opposed to percentage of the base salary before; b) the current practice of scrutinizing new hiring and not automatically filling vacant positions; c) the new civil service law, passed by Parliament in August, will modernize the entire public employment framework.

  • Energy subsidies: The third consecutive phase of electricity tariff increases had been announced early in August 2015. Electricity tariffs were increased by an average of 40 percent effective July 2016, and will be increased further, as planned and announced back in 2014, in 2017/18 and 2018/19, with a view to achieving cost recovery in the coming years. We will resume the fuel subsidy reform program that begun in 2014. Our plan is to gradually eliminate electricity and most fuel subsidies. We raised the retail prices for gasoline and diesel by an average of 35 percent in early November. We will continue the subsidy reform for these products with the objective of achieving average pre-tax price to cost ratios of about 56 percent in 2016/17 (prior action), and in steps to reach 100 percent in 2018/19. In addition, we also increased LPG prices by 87.5 percent. Moreover, in the event of major changes in the oil price or the exchange rate from the projected levels the government will be prepared to adjust fuel prices periodically, or take other measures as needed to keep subsidies at levels consistent with the fiscal targets and to achieve the targeted price to cost ratios. Progress toward achieving these targets will be assessed at each program review.

16. To alleviate the impact of these measures on the poor, about 1 percent of GDP of the savings in 2016/17 have been set aside to be spent on social protection in addition to the amounts allocated in the budget last year (structural benchmark). These include food subsidies and targeted social cash transfers. In addition, within the overall budget envelope, we will preserve or increase other key programs such as social solidarity pensions, children pension, low-cost housing provisions, health insurance and free medicine for the poor, school meals, subsidies for infant milk and medicine for children, transportation subsidies for students and low-income areas, health insurance for young children and female primary providers, and vocational training for the youth. The priority will also be given to the constitutionally mandated health, education and R&D, and also to much-needed investment in public infrastructure. We plan to improve female labor force participation by enhancing the availability and quality of pre-school childcare and will study how to improve the safety of public transport.

17. We will take additional measures, as needed, during the program to achieve our primary balance targets. These may include: better targeting of food subsidies by improving the current smart card system; accelerating energy subsidy reforms; revisiting tax exemptions and other tax expenditures; and further cutting non-priority expenditures.

Public Financial Management and Transparency

18. We will further strengthen public financial management and increase transparency and dissemination of budgetary information. In July 2016, we established a unit within the Ministry of Finance in charge of modernizing public finance management. The new unit has clear mandate and has been staffed with the right and adequate caliber. This will help achieve the fiscal targets, support good governance and accountability in both the public and the private sectors, and promote the efficient and transparent use of fiscal resources. Measures in this area include:

  • Economic authorities. The operational performance and finances of economic authorities will be reviewed to ensure that they are correctly classified in accordance with international standards. Where the economic authorities are found to be providing public functions, proposals will be made to rationalize and incorporate them in the state budget.

  • State guarantees. We will improve our oversight of state issued guarantees to ensure that they are justified and do not expose the public finances to excessive or unnecessary risk. A report on all outstanding guarantees as at end-June 2016 will be prepared by end-January 2017 (structural benchmark), and will serve as the basis for an explicit guarantee ceiling, which will be set for end-June 2017. Concurrently, we will establish a committee of senior Ministry of Finance officials to evaluate all guarantee requests, and advise the Minister on the motivation and risks associated with the request. The terms of reference for the committee will provide guidance on the criteria by which guarantees should be evaluated. We intend to request technical assistance to assist in our capacity in this regard.

  • Social Insurance Fund (SIF). The SIF will benefit from a comprehensive reform to ensure its long-term financial sustainability and preserve its ability to pay adequate and equitable pensions to the retired Egyptians. We will seek technical assistance from development partners and will develop a clear road map of pension reform by June 2017.

  • Medium-term budgeting. We will strengthen our fiscal planning by introducing the medium-term expenditure framework, which will set multi-year expenditure ceilings by major spending categories. Greater prominence will be given to a functional classification of spending plans in budget discussions and budget documentation. We also commit to presenting a pre-budget statement to Parliament with every budget. This statement will brief Parliament on economic and public finance developments. We will also update, if needed, the state budget’s chart of accounts in line with the Government Finance Statistics Manual.

  • Fiscal risks. A crucial step to strengthen public finance management is to develop capacity for monitoring and managing fiscal risks, including those mentioned above. For this purpose, the Ministry of Finance established the new unit mentioned above and will prepare by March 31, 2017 a comprehensive statement of fiscal risks covering all key areas including macroeconomic risks, public enterprises, debt management, contingent liabilities, pensions, and resource mobilization (structural benchmark). The statement will be in addition to the annual report on the financial performance of public enterprises produced by the Ministry of Public Enterprises.

Energy Sector Policies

19. We are launching a comprehensive reform program for the energy sector, which comprises petroleum, gas and electricity and aims to improve the financial position of the sector and raise its efficiency. The current below-the-cost pricing in all three areas (except natural gas) is economically inefficient and not well-targeted. It encourages excessive energy consumption, favors capital-intensive rather than labor-intensive activities, deters private investment in the sector and results in a heavy fiscal burden. The financial performance of the sector is further undermined by weak governance and a high cost structure. Our objective is to modernize the industry and put it on a sound financial footing to ensure uninterrupted and efficient supply of energy products to businesses and households. We intend to gradually remove untargeted subsidies and attract private sector participation. In parallel, the policy making and regulatory functions will be separated, and an independent energy regulator will be formed. The latter will promote competition and establish a transparent pricing mechanism to ensure cost recovery, while also protecting consumers. To help us achieve this objective, we have already contracted a reputable international consultant, which is tasked to perform a diagnostic study and assist us in designing a time-bound road map for our energy sector reforms. The report from the consultant is expected to be delivered by September 30, 2016. Based on the findings of the report, by March 31, 2017 we will develop a medium-term strategy for energy sector reforms (structural benchmark).

20. One of the main challenges is to restructure the Egyptian General Petroleum Company (EGPC). The financial condition of the EGPC has deteriorated significantly since the 2011 revolution. Despite the significant decline in international oil prices, EGPC revenues from sale of fuel products continued to fall short of its costs resulting in the need for budget subsidies and expensive borrowing. Because of its difficult financial position EGPC started accumulating arears to international oil companies. These arrears exceeded $6 billion in 2014 on the back of exceptionally high global oil prices, but have since declined and at end-September 2016 amounted to $3.6 billion. Immediate actions are needed to restore financial sustainability of the EGPC and to minimize risks for the budget. To address the problem, drawing on the recommendations of the external consultant, by March 31, 2017 we will develop an action plan that will place the EGPC on a financially sustainable footing (structural benchmark). In addition to the ongoing fuel subsidy reform, which should improve revenues of EGPC, the plan will propose the ways to strengthen corporate governance and optimize operating costs. As part of the plan, to encourage the private sector participation, we intend to offer minority shares in several state-owned energy companies to investors through the Initial Public Offerings. The plan will also include a strategy to settle the outstanding arrears. Meanwhile, EGPC will ensure that no new arrears are accumulated, and will seek to reach agreements with creditors on the repayment schedule of the current stock to gradually eliminate it by end-June 2019.

21. Egypt has an enormous potential to become a major producer and a supplier of natural gas. Gas production has declined considerably since the 2011 revolution. Daily output fell from 7 billion cubic feet (bcf) in 2010 to about 4 bcf now. However, a number of new fields have been developed in the Nile delta and Egypt’s territorial waters in the Mediterranean in the recent years, of which the Zohr field is the most promising. During 2016/17, gas production is set to increase from 3.8 bcf to 4.9 bcf by June 2017, which will significantly reduce costs of generating electricity as well as the fuel import bill. Over the next three years the gas production form these fields is projected to increase to 7.7 bcf per day, which exceeds Egypt’s domestic need (currently 5.2 bcf per day) and offers an excellent opportunity to save excess quantities for future generations and/or export gas to other countries in the region and elsewhere. Moreover, the ongoing offshore explorations suggest that a presence of even larger deposits of gas is highly likely, which once confirmed will further boost Egypt’s gas potential. Negotiations with international gas exploration companies on development these new fields and on favorable to Egypt production sharing agreements are at an advanced stage.

Financial Sector Policies

22. Egypt’s banking system has weathered well the political transition and multiple shocks, including the global financial crisis of 2007–09 and the economic and political repercussions following the 2011 revolution. Our banks remain well capitalized, liquid and profitable. Asset quality is improving and loan provisioning is adequate. Based on June 2016 data, the average capital adequacy ratio stood at 13.7 percent, well above the Basel-recommended floor of 8.625 percent and the CBE-mandated 10 percent; return on equity is at a healthy 19 percent; the share of non-performing loans in total loans has declined to 6.8 percent from 8.5 percent in 2014 and close to 11 percent in 2011; moreover, loan-loss provisioning is close to 100 percent.

23. The main objective of the program in this area is to preserve and further strengthen the health and resilience of Egypt’s financial system. Our regulatory and policy framework strives to infuse public confidence in the banking system so that it plays the key role in financial mediation and efficiently channels savings into productive investments. We will monitor continuously the developments in the sector to ensure that financial surveillance, lending policies, and governance practices are adequate. Our efforts will be focused on: a) strengthening the regulatory and supervisory framework; b) improving our banking capitalization strategy, which may call for additional resources in light of the added exchange rate and interest rate risks (see below); c) promoting competition to enhance efficiency in the delivery of financial services; d) strengthening the crisis management and resolution framework to mitigate potential systemic risks; and e) promoting financial inclusion by encouraging banks to lend to SMEs, while not compromising credit quality.

24. Exchange rate and interest rate risks are manageable. The negative net open FX position makes banks susceptible to exchange rate depreciation, while large holdings of government debt exposes them to valuation losses should interest rates increase. The CBE’s Banking Supervision department has conducted rigorous bank-by-bank stress tests before moving to the new exchange regime, which found that the banking sector is resilient to exchange rate and interest rate shocks. We will continue monitoring the impact of the exchange rate regime change on banks’ and non-banks’ balance sheet, and will take all measures necessary to maintain the stability and soundness of the banking system. We will also closely monitor currency mismatches on the balance sheets of large corporations and state-owned enterprises to mitigate possible credit risks.

25. We are also taking actions to strengthen banking supervision and the regulatory framework. These will include a) a review of the CBE supervisory model; and b) promoting competition by increasing transparency and reporting requirements.

26. We will further strengthen our crisis response capacity. Our current framework proved to be effective and potent in 2006–07, when we successfully restructured and consolidated our banking system. More than 20 banks have been merged with others or restructured without causing systemic panic or deposit runs. Building on this experience we will continue to further modify and improve our crisis management framework by reviewing and updating the current mechanisms for monitoring and coping with risks in the financial sector, enhancing the early warning systems, including more complex stress-testing techniques, improving governance and failing bank resolution tools, and strengthening emergency liquidity provision arrangements

Business Environment and Other Structural Reforms

27. As part of our development strategy, we are launching a comprehensive program of structural reforms. Our objective is to unlock Egypt’s growth potential, increase exports and industrial production as well create adequate and well-paid jobs to absorb rapidly growing labor force. It is our ambition to significantly improve our ratings in Doing Business and Global Competitiveness, where Egypt’s rank has declined in recent years. In this context, the reform measures we are implementing aim at creating a competitive business environment, attracting investment and increasing productivity to provide fertile ground for private sector activity. The following are the key measures:

  • Our licensing regime imposes significant cost on businesses. We are introducing a one-stop shop for licenses and have passed a law for single proprietorship companies to facilitate the establishment and registration of small companies. Business surveys particularly point to the excessive burden faced by entrepreneurs when dealing with industrial licensing, construction permits, and acquisition of land. We will abolish industrial licensing in Egypt with the exception of industries that affect vital public interests and retain only factory permitting. These remaining industrial licenses will be issued by responsible ministries, and factory permits will be issued by local authorities on a risk-management basis to ensure appropriate land use and compliance with construction, fire, and industrial health and safety codes. The industrial register will be used for statistical purposes only and will not be linked to the exercise of industrial activities.

  • The reform of the Civil Defense and Fire pre-approval is also crucial in parallel to reforming industrial licensing. Under the new system we will establish a threshold for low risk production facilities, and will review the fire code to ensure consistency, adequacy, appropriateness, and simplicity. This reform will also have a direct impact on reducing the duration for obtaining Construction Permits.

  • Similarly, we are simplifying our bankruptcy and liquidation procedures, which currently discourage investment and risk-taking. We have already prepared a revised draft insolvency law in line with best international standards that will be submitted to the Parliament for consideration before end-2016 and is expected to be adopted no later than June 30, 2017.

  • Lack of collateral is often cited as an important obstacle to getting credit, especially for small and medium enterprises. To ease the severity of the problem we will develop an efficient collateral registry by end-March 2017.

  • Egypt’s non-oil exports of goods are only 4 percent of GDP, which is exceptionally low by international standards. To better utilize our export potential, by end-March 2017 we will develop an action plan to improve the focus of the export promotion regime. We will target the reduction of non-tariff barriers.

  • Reducing high unemployment is a high priority, especially among women and youth for which both labor participation and employment statistics are particularly poor. While the macroeconomic policies and structural reforms that we are adopting will all support job creation, we also intend to enhance active labor market policies. We are developing specialized training programs for youth and job intermediation schemes. We also commit to spend around EGP 250 million to improve the availability of public nurseries and other facilities that can enhance the ability of women to actively seek jobs (structural benchmark). In addition, we will form a joint committee that includes relevant stakeholders including Ministry of Labor, Ministry of Social Solidarity, Ministry of Finance, Ministry of Trade and Industry as well as representatives of the Women’s council, academia and business community. The committee will be tasked to come up with clear intervention measures that can improve women participation rate in the labor force, for example improvements to transportation safety.

  • The announced five-year IPO program is part of the government’s agenda to unleash potential of Egypt’s public assets, widen ownership base, enhance transparency and corporate governance in state owned companies, diversify investment sources, and attract investments worth $5bn over three years. Consultations are underway with several investment banks and legal consulting firms to put together a list of potential companies along with a detailed plan, including timing and valuation. The initial focus is on viable successful companies in the following sectors: banking and financial services, oil and gas, petrochemicals, building materials, and real estate development. The first offering is expected to take place in the first quarter of 2017.

D. Financing and Program Monitoring

28. In support of this program, we will continue to mobilize funds from international partners to cushion the adjustment and help us close the remaining financing gap. The current projections suggest that with the policies outlined in this memorandum the remaining financing gap for the next three years (the program period) will amount to about $35 billion, of which $16.3 billion is for 2016/17. To close the 2016/17 gap, we have secured $1 billion from the UAE, $2.7 billion from China as part of a currency swap, $1 billion from the World Bank, rolled over the $3.2 billion loan from Afreximbank, $1.35 billion from a repo transaction with foreign commercial banks, $950 million from the Eurobond, $250 million from Germany, $150 million from the U.K., $150 million from France, and $50 million from Japan. We expect $4 billion from the IMF under the EFF arrangement, and $1 billion from the second tranche of the World Bank’s Development Policy Financing, and $0.5 billion from the African Development Bank.

29. The program will be monitored through prior actions, quantitative performance criteria, indicative targets and structural benchmarks. Semi-annual program reviews will be based on December and June test dates. All quantitative performance criteria and indicative targets are listed in Table 1, and prior actions and structural benchmarks are set out in Table 2 below. The Technical Memorandum of Understanding is also attached to describe the definitions of quantitative PCs and, consultation as well as data provision requirements.

Table 1.

Egypt: Quantitative Performance Criteria (PC) and Indicative Targets (IT) Under the EFF Arrangement July 2016–June 2017

(In billions of Egyptian pounds unless otherwise indicated)

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Note: For precise definitions of the aggregates shown and details of the adjustment clauses, see the Technical Memorandum of Understanding (TMU).

Cumulative from the beginning of the fiscal year (July 1).

Table 2.

Prior Actions and Structural Benchmarks

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Attachment II. Technical Memorandum of Understanding

November 7, 2016

1. This memorandum sets out the understandings regarding the definitions of quantitative performance criteria, indicative targets, and the consultation clause, as well as the data reporting requirements for the extended arrangement under the Fund’s Extended Fund Facility (EFF) arrangement. The quantitative performance criteria and indicative targets are reported in Table 1 of the MEFP.

2. Program exchange rates are those prevailing on June 30, 2016.

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For all other foreign currencies, the current exchange rates to the U.S. dollar will be used. Monetary gold is valued at $1,258.65 per troy ounce.

A. Floor on Net International Reserves (PC)

3. Net international reserves (NIR) of the Central Bank of Egypt under the program are defined as the difference between foreign reserve assets and reserve-related liabilities. The program targets the change in NIR which is calculated as the cumulative change since the beginning of the fiscal year. NIR is monitored in US$ and for the program monitoring purposes assets and liabilities in currencies other than US$ are converted into dollar equivalents using the program exchange rates.

4. Foreign reserve assets are defined consistent with SDDS as readily available claims on nonresidents denominated in convertible foreign currencies, including the Chinese Yuan. They include the CBE holdings of monetary gold, SDRs, foreign currency cash, foreign currency securities, deposits abroad, the country’s reserve position at the Fund and other official reserve assets. Excluded from foreign reserve assets are any assets that are frozen, pledged, used as collateral, or otherwise encumbered, including but not limited to assets acquired through short-term currency swaps (with original maturity of less than 360 days), claims on residents, precious metals other than gold, assets in nonconvertible currencies, and illiquid assets. As of June 30, 2016, foreign reserve assets thus defined amounted to $17,097 million.

5. Foreign reserve-related liabilities are defined as comprising all short-term foreign exchange liabilities of the CBE to residents and nonresidents with original maturity of less than 360 days, including government’s foreign currency deposits with original maturity of less than 360 days, banks’ required reserves in foreign currency, and all credit outstanding from the Fund, which is on the balance sheet of the CBE. As of June 30, 2016, reserve-related liabilities thus defined amounted to $9,144 million.

6. Adjustors. The NIR floor will be adjusted up (down) by the full amount of the cumulative excess (shortfalls) in program disbursements (as defined in paragraph 7) relative to the baseline projections shown under the memo items in Table 1.

7. Program disbursements are defined as external disbursements of loans (including IMF disbursements), grants and deposits for the budget support purposes, foreign reserve asset creating loans and deposit to the CBE with the original maturity of more than 360 days, and rollovers by more than 360 days of existing foreign loans and foreign reserve-related liabilities, in foreign currency, from official multilateral creditors, official bilateral creditors, and private creditors, including external bond placements. Program disbursements exclude project loans and grants.

B. Ceiling on Average Reserve Money (IT)

8. Reserve money (RM) is defined as the sum of currency in circulation outside the CBE, and balances on commercial banks’ correspondent accounts and required reserves in local currency at the CBE (this excludes balances in deposit auctions and in term deposits at the CBE). For each semester, average reserve money is calculated from daily balance sheets of the CBE as the average for the last month of the semester. For the second semester of 2015/16, average reserve money amounted to EGP460.67 billion.

9. Adjustor. In the event of a change in reserve requirement ratio (rr) in local currency, the reserve money ceiling will be adjusted according to the formula:

Revised RM ceiling = Program RM ceiling + banks’ correspondent accounts in local currency  × ( new rr/old rr )
C. Ceiling on Net Domestic Assets of the CBE (PC)

10. Net domestic assets (NDA) of the CBE under the program are defined as the sum of net credit of the government, net credit to public economic authorities, credit to banks, and open market operations, excluding foreign currency components such as loans and deposits of the government, public economic authorities and banks. As of June 30, 2016, NDA of the CBE amounted to EGP626.37 billion.

Adjustors.

  • 1) NDA targets will be adjusted down (up) by the full amount of the cumulative excess (shortfall) relative to the baseline projections shown under the memo items in Table 1 in external budget support loans and grants, in U.S. dollars, from official multilateral creditors, official bilateral creditors, private creditors, and external bond placements. Project loans and grants are excluded. The U.S. dollar amounts will be converted in Egyptian pounds using the official EGP/$ exchange rate on the day of disbursement.

  • 2) In the event of a change in reserve requirement ratio (rr) in local currency, the NDA ceiling will be adjusted according to the formula:
    Revised NDA ceiling = Program NDA ceiling + banks’ correspondent accounts in local currency ×(new rr/old rr)
D. Floor on Primary Fiscal Balance of the Budget Sector (PC)

11. The general government comprises the budget sector, the Social Insurance Funds and the National Investment Bank (NIB). The budget sector comprises the central government (administration), the governorates (local administration) and public service authorities, including the General Authority for Government Services, other regulatory authorities and supervisory agencies, funds, universities and hospitals.

12. The primary balance of the budget sector under the program is defined as the overall balance of the budget sector plus total interest paid. The overall balance is measured from the financing side and includes the following with the minus sign: (i) net domestic financing of the budget sector; and (ii) net foreign financing of the budget sector. For the fiscal year 2015/16 these variables amounted to EGP341.3 billion and EGP-4.5 billion, respectively.

  • i. Net domestic financing consists of:

    • ➢ The cumulative change from the beginning of the fiscal year of the outstanding stocks of loans, advances, and overdrafts of the budget sector (as defined in paragraph 12) from the CBE, holdings of government securities and promissory notes by the CBE, and all other CBE accounts receivable due from the budget sector, minus all deposits of the budget sector at the CBE.

    • ➢ The cumulative change from the beginning of the fiscal year of the outstanding stock of loans, advances, and overdrafts of the budget sector from domestic commercial banks, holdings of government securities and promissory notes by domestic commercial banks, and all other accounts receivable by commercial banks from the budget sector, minus all deposits of the budget sector at domestic commercial banks.

    • ➢ The cumulative change from the beginning of the fiscal year of the outstanding stock of domestic debt held outside the central bank and domestic commercial banks including domestically issued government securities held by non-residents. This includes the private sector as well as loans and advances to, and holdings of government securities and promissory notes by public entities not covered by the budget sector accounts, with the exception of bonds issued by the government to the Social Insurance Fund (SIF) to securitize the past arrears.

  • ii. Net external financing is measured on a cumulative basis from the beginning of the fiscal year and is defined as disbursements minus amortization of budget support loans, project loans, Euro-bonds and similar instruments, and any other forms of government external debt, excluding domestically issued government securities held by non-residents. The definition of debt is set out in point 8 of Guidelines on Public Debt Conditionality in Fund Arrangements (Executive Board Decision No. 15688-(14/107 adopted on December 5, 2014). Net external financing will be measured in domestic currency at the official exchange rate on the date of the transactions.

  • iii. Interest paid is measured on a cumulative basis from the beginning of the fiscal year and is defined as the total interest bill paid by the budget sector on all its interest bearing liabilities. In FY 2015/16 total interest paid amounted to EGP241.5 billion.

  • iv. For 2015/16 the primary deficit of the budget sector amounted to EGP95.3 billion

13. Off-budget funds. The authorities will inform IMF staff of the creation of any new off-budgetary funds or programs immediately. This includes any new funds, or other special budgetary and extra-budgetary programs that may be created during the program period to carry out operations of a fiscal nature as defined in the IMF’s Manual on Government Finance Statistics 2001.

14. Adjustor. The target for the primary balance of the budget sector will be adjusted up (down) by the full amount of the shortfall (excess) in the disbursement of external project loans, i.e. the disbursement shortfalls will reduce primary deficits and excesses will increase them. The U.S. dollar amounts will be converted into Egyptian pounds using the official EGP/$ exchange rate on the day of the disbursements.

E. Tax Revenue (IT)

15. Tax revenue includes personal income tax, corporate income tax, GST/VAT, excises, international trade taxes, and other taxes.

F. Fuel Subsidies (PC)

16. Fuel subsidies are defined as total amount of subsidies paid by the budget sector for gasoline, diesel, kerosene, LPG and fuel oil. These subsidies are measured in domestic currency on a cumulative basis from the beginning of the fiscal year.

G. EGPC Arrears (IT)

17. EGPC arrears. This ceiling will apply to accumulation of EGPC arrears to foreign creditors (international oil companies) on a net basis, reflecting the common industry practice of attributing payments to the most overdue receivables. EGPC arrears will be measured in $. As of September 30, 2016 the stock of EGPC arrears amounted to $3.6 billion.

H. Continuous Performance Criteria

18. Non-accumulation of external debt payments (principal and interest) arrears by the general government (as defined in paragraph 12). No new external debt payments (including on long-term leases) arrears will be accumulated during the program period. For the purposes of this performance criterion, an external debt payment arrear is defined as an amount of payment obligation (principle and interest) due to nonresidents by the general government and the CBE, which has not been made when due under the contract, including any applicable grace period. The performance criterion will apply on a continuous basis throughout the arrangement.

19. Standard continuous performance criteria include: 1) prohibition on the imposition or intensification of restrictions on making of payments and transfers for current international transactions; 2) prohibition on the introduction or modification of multiple currency practices; 3) prohibition on the conclusion of bilateral payments agreements that is inconsistent with Article VIII; and 4) prohibition on the imposition or intensification of import restrictions for balance of payments reasons.

I. Consultation Clause

20. Direct sales of foreign exchange to SOEs and the government include sales of foreign exchange by the CBE to the government other than for debt service and to SOEs such as EGPC, GASC, and other.

21. If foreign exchange sales (including direct sales to SOEs and the government) are excessive, a consultation will be held with the IMF Executive Board on policies comprising the following: (i) the stance of monetary policy; (ii) the reasons for deviations from the program targets, taking into account compensating factors; and (iii) necessary remedial actions.

J. Monitoring and Reporting Requirements

22. Performance under the program will be monitored using data supplied to the IMF by the Ministry of Finance and the CBE as outlined in Tables 3A and 3B, consistent with the program definitions above. The authorities will transmit promptly to the IMF staff any data revisions.

K. Data Reporting
Table 1.

Ministry of Finance

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Note: M = Monthly; W = Weekly
Table 2.

Central Bank of Egypt

article image
Note: Q = Quarterly; M = Monthly; W = Weekly
1

Excluding grants, the adjustment was about 4 percentage points of GDP.

2

At factor costs, real GDP is estimated to have grown by only 2.5 percent, but larger net indirect taxes due to the reduction in subsidies pushed up growth at market prices.

3

A MCP arises from the multiple price auction system established by the CBE, as the exchange rates for spot transactions in an auction may differ by more than two percent.

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Cover IMF Staff Country Reports
Arab Republic of Egypt: Request for Extended Arrangement Under the Extended Fund Facility-Press Release; Staff Report; and Statement by the Executive Director for the Arab Republic of Egypt
Author:
International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2017: Issue 017
Publisher:
International Monetary Fund
ISBN:
9781475566901
ISSN:
1934-7685
Pages:
83
DOI:
https://doi.org/10.5089/9781475566901.002

Exchange Rate

(Egyptian pounds per $)

Contributions to GDP growth

(percent)
Figure 1.

Egypt: Real Sector Developments
Figure 2.

Egypt: Fiscal Sector Developments
Figure 3.

Egypt: External Sector Developments
Figure 4.

Egypt: Monetary Sector Developments

Egypt Public DSA Risk Assessment

Egypt Public DSA - Realism of Baseline Assumptions

Egypt Public DSA - Stress Tests

Egypt Public DSA - Stress Tests

Egypt Public DSA - Composition of Public Debt and Alternative Scenarios

Egypt: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)