Egypt’s economy is strengthening on many fronts, reflecting sound policy implementation, improved outlook, and confidence gains. On the macro-side, GDP is estimated to have risen to over 5 percent despite a sizeable fiscal consolidation in the year ending June 2018; the primary fiscal deficit is estimated to have shifted to a small surplus; public debt will have significantly declined as a share of GDP; international reserves nearly tripled from their low point and now exceed their earlier peak in 2010; and inflation was brought down to 11.4 percent in May 2018 after having soared to over 33 percent. Wide-ranging structural reforms were implemented, despite the socio-economic and technical challenges. The resulting confidence gains have contributed to deeper access to international financial markets and upgrades from rating agencies. The authorities remain guided by the objectives of their homegrown program and their vision to build on recent gains in macroeconomic stabilization, transform the economy, and deliver better prospects for all. They realize that significant challenges remain to deliver on the promises to the Egyptian people, who wait to see the fruits of their sacrifices, for which they deserve the highest recognition.
Communication has been key to public acceptance. The authorities consistently communicate the rationale for difficult reforms that entail considerable public sacrifice, supported by the leadership’s statements, at the highest level, explaining the vision for Egypt. The newly formed cabinet has demonstrated continuity, with the new PM Madbouly approving proposals prepared by the prior cabinet in his first hours in office. President ElSisi has tasked the new cabinet, which held its first meeting on June 21, to (i) work toward a growth target of 7 percent while further reducing the budget deficit, unemployment, and inflation; (ii) keep national security a priority; (iii) improve the quality of life for citizens; (iv) expand protections for low-income earners; (v) improve education; and (vi) improve government services.
The authorities share staff’s assessment of the favorable outlook and risks. Continued recovery of tourism and rising natural gas production should help support growth in the near-term. The recent broad shift in investor sentiment away from emerging markets could lead to further tightening of financial conditions that will need to be evaluated in the period ahead. Uncertainties also relate to global oil prices, any deterioration in the security situation, or the possible drag on the reform momentum from adjustment fatigue.
The CBE plans to maintain a tight monetary policy and a flexible exchange rate. The tight monetary stance has brought down inflation following the large devaluation and series of price hikes, in order to firmly anchor inflation expectations. The CBE is keenly aware of second-round effects from recent increases to energy and other prices (water, metro, and other public transport, etc.). Consistent with the commitment to a flexible exchange rate, CBE has refrained from any intervention since the floating of the pound. Market supply and demand factors, strong portfolio inflows, and banks’ rebuilding of net foreign assets have helped the pound stabilize. All in all, the Egyptian pound lost two-thirds of its value relative to 2010, boosting net exports to become an important contributor to GDP growth this year, and allowing the current account deficit to sharply narrow to an estimated 2½ percent of GDP and it is likely to narrow further. Portfolio inflows, which were on a steady upswing, reaching 7 percent of GDP, have seen a tapering off and outflows in recent weeks due to the dampened sentiment towards EMs across the board and not for Egypt-specific reasons.
The fiscal consolidation is among the largest planned and achieved under a Fund-supported program. With budget deficits exceeding 10 percent of GDP for several years, debt service accounting for 30 percent of total spending and 10 percent of GDP, and general government debt surpassing 100 percent of GDP last year, a large fiscal consolidation was inevitable and considered a key anchor to the stabilization effort. Despite the large devaluation and much higher oil prices than projected at the start of the program, which led to an over-run of the fuel subsidy bill by 0.3 percent of GDP, the budget position is expected to shift to a small primary surplus this year.
With further consolidation measures next year, the primary surplus is targeted at 2 percent of GDP and general government debt to decline (from 103 percent of GDP in 2016/17) to 86 percent of GDP in 2018/19. The primary surplus will be maintained at 2 percent of GDP and debt will decline further to 74 percent of GDP by 2022/23. Debt service cost is projected to decline by 4 percent of GDP over the medium-term. In addition, an automatic price adjustment mechanism was approved by the Prime Minister in June for implementation during 2018/19 to lock-in fuel subsidy reform gains and avoid the recurrence of fuel subsidies. The Minister of Petroleum just publicly affirmed this week that fuel subsidies would be eliminated completely by next year.
The financial sector has proven to be strong, profitable, well-regulated and supervised, and resilient to shocks, as verified by Fund experts. The large public banks are comfortable with their current and projected capital positions and, given their continued profitability, consider themselves well-positioned to manage the planned expansion of operations mainly from internally generated capital, and to easily withstand moderate shocks. Banks’ capital adequacy ratios stood at over 15 percent in December 2017, and NPL ratios had further declined to 4.9 percent with virtually full provisioning (99 percent). Banks expect private sector credit growth to be revived from currently low levels, once interest rates decline from historically high levels as inflation expectations become durably anchored.
The Ministry of Finance is modernizing its operations, improving transparency and accountability, and further enhancing institutional capacity. Notably, a fiscal strategy paper was submitted to Cabinet in December 2017 and an updated statement of fiscal risks is being finalized with procedures for assessing new state guarantees. A report on public enterprises is to be completed this week to provide a more complete picture of public sector operations. Tax collection will be modernized by integrating the organization structure of income taxes and VAT, and utilizing upgraded IT systems and processes. Gender-budgeting is to be introduced in 2018/19 with the help of United Nations Women program, and several initiatives aim to support women’s financial inclusion, training, and labor force participation.
Structural reforms aim to facilitate private sector activity and encourage investment. The adoption of a new investment law, establishment of a consolidated investment center, and simplification of licensing procedures were important steps in the past year—and the authorities are working on many other fronts, including those reflected in the MEFP. A working group is being established to review the allocation mechanism for industrial land and identify potentially needed reforms. A new government Procurement Law was recently approved and is expected to encourage broader participation by the private sector, while a single e-Procurement portal will handle all public procurements. Other steps are being considered to support competition and reassure private investors of an even handed playing field. Last April a detailed plan was announced on the divesture of stakes in at least 23 public entities over 24–30 months, of which the first 4 would be completed in the next fiscal year.
A few words of appreciation. The authorities are highly appreciative of everyone on the IMF team. Candid and constructive discussions are building a good partnership. The May conference in which Mr. Lipton participated usefully touched on the many remaining challenges and the transformative reforms that other countries implemented over a decade or more, and emphasized that Egypt needs to accelerate the pace of the planned transformation.
Looking forward. Recent economic gains provide an important motivation to continue with the still large and complex reform agenda so that the benefits can be shared more broadly. The Egyptian people have endured hardships from reforms deemed inevitable to correct earlier imbalances and to place the economy on a path of more inclusive growth. Their endurance, and persistent reform efforts, are critical to realizing the vision of transformative economic change.