IMF Policy Paper: Statement by Mr. Beblawi, Executive Director for Arab Republic of Egypt and Ms. Abdelati, Senior Advisor to Executive Director

2017 Article IV Consultation, Second Review Under the Extended Arrangement Under the Extended Fund Facility, and Request for Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for the Arab Republic of Egypt


2017 Article IV Consultation, Second Review Under the Extended Arrangement Under the Extended Fund Facility, and Request for Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for the Arab Republic of Egypt

We thank staff for a comprehensive set of reports and for the candid discussions that enrich the dialogue. Staff agrees with our authorities’ strategy to raise Egypt’s growth rate and to generate jobs and economic opportunities for the population. Our authorities continue to implement their homegrown program, whose credibility was supported by approval of an EFF arrangement one year ago. So far, performance is strong and program objectives are on track and, in some instances, ahead of schedule. The staff papers reflect the positive impact of recent reforms on confidence and economic prospects, and our authorities are hopeful that Egypt will see more substantive gains in 2018 and beyond as they maintain the accelerated reform momentum. This Article IV discussion offers an opportunity to reflect on Egypt’s medium-term economic potential, beyond the immediate measures covered under the EFF program.

Floatation of the pound a year ago, together with a fiscal consolidation plan made possible by tax and energy price reforms, marked a key milestone and is widely recognized as a gamechanger for Egypt’s economy. As part of the shift to a new economic growth model, the authorities have proceeded to implement policies to further entrench the gains in macroeconomic stabilization, improve competitiveness, streamline the investment environment and encourage private sector dynamism. The main elements of the authorities’ program continue to be (i) tight monetary policy to bring down inflation to single digits over the medium-term, while maintaining a market-determined exchange rate; (ii) strong fiscal consolidation to lower the general government debt to sustainable levels and to create fiscal space for countercyclical policies; (iii) structural reforms to promote higher, private-sector-led, and more inclusive growth and employment; and (iv) stronger and better targeted social safety net to offset the impact of reforms on the vulnerable. We would underscore that a paradigm shift has already taken place as outlined below.

Recent Developments and Outlook. Growth accelerated for four consecutive quarters, reaching 5.2 percent in July-September 2017, compared to 3.4 percent in the same quarter of the previous year, unemployment has declined, inflation continued to decline from the peaks reached following the pound floatation and energy price reforms, fiscal consolidation advanced, and the external position strengthened, while inflows exceeded original program expectations. In the most recent quarter, the current account deficit narrowed markedly compared to a year earlier (to just $1.6 billion for July-September 2017 compared to $4.8 billion for July-September 2016), due to stronger remittances, tourism receipts, and lower travel payments. Positive market sentiment reflects growing credibility of economic management. Nevertheless, the authorities are aware that the Egyptian economy is exposed to adverse influences from geopolitical risks and their impact on oil prices and financial flows.

Monetary and External Policies. The CBE has announced an inflation target of 13 percent for end-2018 and intends to adopt full-fledged inflation targeting (FFIT) once all conditions are in place. In the transition period, inflation objectives are met by steering short-term interest rates, while monitoring money and credit developments and other factors that may influence underlying inflation. Interest rates, that were raised by a total of 700 bp between November 2016 and July 2017, were kept on hold in spite of four consecutive months of lower inflation data, and the authorities will consider a measured easing of the monetary stance only once totally comfortable that risks surrounding inflation have subsided. A recent IMF TA mission confirmed that the CBE follows good practices with respect to liquidity management and its forecasting framework. Monetary operations rely on indirect policy instruments to control liquidity. Lending to finance the public deficit has been capped through a limit on the overdraft account at below 10 percent of the previous three years’ average tax revenues.

Following sharp fluctuations just after its floatation, the Egyptian pound has stabilized, and official reserves strengthened. Reserves are approaching the upper bound of the Fund’s reserve adequacy range, which the authorities consider necessary to maintain market confidence. As before, the exchange rate will remain market-determined, and the CBE will not intervene in the interbank FX market, except if unusually large short-term flows pose stability risks to the FX market. As a signal of normalizing market conditions, the CBE removed the remaining FX restrictions and introduced a fee of 100 bp on foreign investors wishing to sell FX to the CBE at entry via the repatriation mechanism. CBE disagrees with staff statements that the repatriation mechanism has diverted FX liquidity from the interbank market and prevented the appreciation of the currency in response to portfolio inflows because (i) at the outset, the program had expected a much more appreciated Egyptian pound without counting on portfolio inflows; (ii) the large majority of FX receipts is generated organically from daily economic activity and goes into the interbank market; and (iii) investors say short-term inflows would have been much lower without a repatriation mechanism. Separately, a mechanism has been introduced to eliminate the multiple currency practice (MCP) arising from the potential that exchange rates for spot market transactions in the auctions may differ by more than two percent, even though the auction has not operated since the float.

While the external sector assessment is benign, it yields contradictory results, perhaps unavoidable, when using historical trends while Egypt undertakes transformative policies. The substantial current account improvement in the quarter of July-September 2017/18 is much stronger than staff projected and suggests the projected deficit for FY2017/18 is overstated, as is the projected medium-term current account gap of 1 percent based on EBA-Lite estimates. A discussion of staffs methodology, the adjustments made, and the underlying data files and calculations could be planned in the form of a workshop during the next mission.

Fiscal Policy. The overriding goal is to place government debt on a declining trend and to reduce it to 87 percent of GDP by 2018/19, as adjusted in view of the revision of the stock of debt due mainly to exchange rate valuations. The primary deficit for the fiscal year ending June 2017 was in line with expectations, but the higher than expected interest rates pushed the overall deficit beyond targets, in spite of considerable off-setting measures. The authorities still aim to achieve a cumulative fiscal consolidation of 51/2 percent of GDP by 2018/19 and reach a primary fiscal surplus of 2 percent of GDP in 2018/19 to place debt on a declining path. In the current fiscal year, ending June 2018, the authorities aim at a primary deficit of 0.2 percent of GDP, which constitutes a fiscal adjustment of 2 percent of GDP compared to the previous year and 3.8 percent of GDP compared to 2015/16.

A number of revenue measures will help achieve the 2017/18 fiscal consolidation, including increases in the excises on tobacco products, the VAT rate, and duties and fees on various licenses and government services, as well as a new stamp duty on stock market transactions. But most of the adjustment will come from the expenditure side, primarily from energy subsidies and the wage bill (each to decline by around 1 percent of GDP).

To strengthen the institutional framework for fiscal policy, the authorities have embarked on administrative reforms within the Ministry of Finance. A fiscal strategy paper has been completed, and they recently issued principles to govern the issuance of state guarantees. They plan to introduce a medium-term expenditure framework as a step towards program based budgeting with Fund support. The authorities are currently reviewing the operational performance and finances of economic authorities and of state-owned enterprises with a view to improve the efficiency of public resources and accountability. A review and a road map for reform of the Social Insurance Fund is also planned.

Efforts continue to deepen the social safety net, enhance the targeting of social transfers, and expand coverage to newly identified needy individuals. The Ministry of Social Solidarity has improved the database of households eligible for social assistance. The food subsidy program more than doubled the monthly semi-cash allowance for each beneficiary. Budgetary outlays for nurseries was also doubled in the current budget. A committee was established in April 2017 to improve women’s participation in the labor force, and the authorities are working to implement gender budgeting starting with FY18/19.

Financial Sector Policies. Egypt’s financial system is profitable, liquid, and well capitalized, well above Basel III requirements, and the CBE is actively seeking to continuously upgrade its oversight frameworks. Nonperforming loans remain stable at 5.5 percent of total loans even after the exchange rate and interest rate shocks, and loan loss provisioning covers 91 percent. CBE’s banking supervision department conducts rigorous bank-by-bank stress tests of the impact of adverse macroeconomic scenarios. The results of CBE’s stress tests and detailed results of its intensive supervision were shared with the staff team who had expected to see a significant adverse impact of the exchange rate and interest rate shock, which was not found, so we trust this fully reassured staff of the strength of regulation andsupervision.

With the help of outside advisors, the CBE prepared amendments to the banking law that, in the first instance, focused on the recommendations from the Safeguards Assessment and most of the recommendations received from MCM and LEG. The current banking and monetary system law, No. 88 of 2003, mandates the central bank to ensure price stability and banking soundness. Low inflation is considered essential to maintain business confidence, investment, and growth. Regarding the ongoing redrafting of the law, the CBE aims to modernize it in line with domestic needs and global best practices, enhancing governance and independence of the CBE, as well as accelerating the momentum toward greater financial inclusion. However, there is a tradeoff between complexity and comprehensiveness, and timely implementation of the elements most relevant for Egypt’s current situation.

Financial Inclusion. Recognizing its critical importance for inclusive growth, job creation and for reducing poverty and inequality, the CBE has raised the profile of financial inclusion. It is considered essential to reach the under-served to enable them to save safely, with particular focus on increasing access to finance for women, youth and micro and small enterprises. This has been complimented by efforts to shift to digital and online services, including with the establishment of the National Payment Council in February 2017.

Structural Reforms—Energy. In the energy sector, a combination of higher production, price reform, reliance on renewables, increased competitiveness from the private sector, and ongoing operational efficiency gains aim to raise production, bring down cost per unit of production, and reduce the fiscal burden. Production had declined post-2011 partly due to FX shortages and subsidized pricing that led to a built-up in arrears to foreign partners. However, most of the arrears were paid back since 2014 and revised production sharing agreements incentivized exploration and production activity culminating in the discovery of the giant gas field Zohr among others. Domestic gas prices already cover costs, and industries that once relied on cheap gas prices are no longer subsidized. Electricity prices were raised several times as announced in 2014, and a block tariff structure charges escalating rates to discourage high usage. Fuel price adjustments have brought the price to cost ratio (gasoline and diesel) to 68 percent by September 2017, which would have been higher if it weren’t for the huge devaluation that substantially increased the cost of petroleum products in local currency and partially offset the savings from price adjustments. Starting December 2017, the authorities began publishing information on fuel product unit costs, as a first step toward introducing an automatic fuel price adjustment mechanism, and are developing a public communication strategy.

Egypt’s energy sector is well-placed to become a regional hub, a major growth driver, an investment destination, a transit route, and an exporter. Towards that purpose, the authorities embarked on liberalizing the energy sector by separating the operational and regulatory functions of public enterprises in the sector and opening the door for more private sector involvement. Within this framework, a new Electricity Law was issued in 2015, which paved the way to sizeable private investments (worth US$1.8 billion) in renewable energies through the Feed-in Tariff program. A new Gas Law was passed in July 2017 to allow private sector involvement in downstream activities. Following new exploration contracts and new discoveries, production rebounded and exports over domestic consumption needs are to begin as soon as next year, while new discoveries are considered likely.

Improving Competitiveness and the Business Climate. To unlock Egypt’s growth potential, raise export’ competitiveness, and create more private sector jobs, the authorities have embarked on a broad-based strategy of market-friendly reforms. In 2017, Parliament passed a new investment law and an industrial land and licensing law. The Ministry of Investment has opened an investor center to facilitate all approval and licensing procedures in one location. The authorities are implementing a plan to improve the finances, operating efficiency, and corporate governance of the Egyptian General Petroleum Company and Egyptian Electricity Holding Company to enable them to engage in commercial transactions without Government guarantee and/or support. Access to industrial land has become more readily available as nearly 17 million sqm of land was provided in 2016/17 compared to 9.5 mn for the whole period of 2007-15. An inter-ministerial committee was established in October 2017 to further develop the announced plans to divest shares in public companies, initially in the areas of financial services, oil and gas, petrochemicals, building materials, and real estate, with a view to reduce the role of the state and improve market capitalization. The Export Development Authority was set up, in cooperation with the International Trade Center of Geneva, as one of several initiatives to support exporters. During 2017, the number of documents required to export was reduced from 9 to 5, and to import from 11 to 6, and a further reduction is targeted in 2018 that aims to reduce the time to export to 2days.

Key reforms in the pipeline include a new bankruptcy law, currently with Parliament, and a single proprietor company law that aims to encourage SMEs. A new public procurement law was already presented to Parliament and the establishment of a single portal for government procurement aims to increase access to government procurement information, improve transparency, and encourage SME participation. The authorities plan to liberalize the transportation sector by engaging the private sector in public transportation and establish an independent regulatory authority, that is separated from the Cairo Transport Authority. In line with the reforms to improve governance and accountability of public sector entities, the authorities plan to publish in early 2018 the financial accounts of the economic authorities for FY 2016/17.

Upgrading infrastructure has been a key element to enhance the investment climate, with an unprecedented pace of development in the past three years. Power capacity was increased by over 50 percent to meet growing domestic demand. The Suez Canal was expanded within one year to more than double its capacity, four tunnels are near completion as well as four floating bridges to improve connectivity between Sinai and the main land and facilitate developments efforts in Sinai’s lagging areas. The newly established Suez Canal Axis Development Authority has recently signed agreements for new investment projects for the development of ports. Twenty-two industrial clusters are planned that would make available utilities and logistical support to small and large investors. New roads have been extended, representing 44 percent of planned new roads and a 15 percent increase over existing roads as of April 2017.

Entrepreneurship and Innovation. With improved overall confidence and growing credibility of the government’s program, private sector entrepreneurship is becoming more visible, and there is growing interest by foreign investors, including in the newly established industrial free zones. Egypt has been highlighted as the fastest growing location for startups with growth of over 100 percent in the last year, reaching over 500 registered startups, and with very promising prospects for rapid growth. The MOIC initiated an incubator scheme which has received a large number of applications and provided entrepreneurship training. A range of other training programs for entrepreneurs, youth, women, and technical support services has been established or expanded, and the vocational training curricula has been upgraded. In addition to the financial inclusion efforts of the CBE, several initiatives support access to finance and entrepreneurship, including a movable assets law, a new microfinance law, a mortgage financing scheme, a financial leasing and factoring law, and reduced flat tax rates for SME to be introduced by end 2018.

We trust that the staff reports and our statement provide Directors with a flavor of the authorities’ ambitious wide-scale economic reform program, and achievements to date, which they believe is necessary to unlock the immense potential of the Egyptian economy and improve opportunities for all. We take this opportunity to thank staff and management, and to thank Directors for their continued support to Egypt, including during the last two Board discussions.