Arab Republic of Egypt: First and Second Reviews Under the Extended Arrangement Under the Extended Fund Facility, Monetary Policy Consultation, and Requests for Waiver of Nonobservance of a Performance Criterion, and Augmentation and Rephasing of Access-Press Release; and Staff Report
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1. External shocks and delayed policy adjustments have weighed on economic activity. Growth slowed to 3.8 percent in FY2022/23 due to weak confidence and foreign exchange shortages, which constrained overall investment (Figure 1). The health of the non-oil private sector remains frail based on the headline Purchasing Managers’ index, which has been in contractionary territory since 2021. The conflict in Gaza and Israel and the disruptions in the Red Sea are further exacerbating these pressures. Suez Canal revenues, an important source of foreign exchange for Egypt, fell almost 50 percent yoy in January 2024 (a loss of around US$375 million relative to January 2023). Despite a sharp fall in remittances through banks (Figure 2), with foreign exchange being diverted away from the official market, the current account deficit narrowed to 1.2 percent of GDP in FY2022/23 as imports were compressed due to limited foreign exchange availability.

Abstract

1. External shocks and delayed policy adjustments have weighed on economic activity. Growth slowed to 3.8 percent in FY2022/23 due to weak confidence and foreign exchange shortages, which constrained overall investment (Figure 1). The health of the non-oil private sector remains frail based on the headline Purchasing Managers’ index, which has been in contractionary territory since 2021. The conflict in Gaza and Israel and the disruptions in the Red Sea are further exacerbating these pressures. Suez Canal revenues, an important source of foreign exchange for Egypt, fell almost 50 percent yoy in January 2024 (a loss of around US$375 million relative to January 2023). Despite a sharp fall in remittances through banks (Figure 2), with foreign exchange being diverted away from the official market, the current account deficit narrowed to 1.2 percent of GDP in FY2022/23 as imports were compressed due to limited foreign exchange availability.

Recent Developments

1. External shocks and delayed policy adjustments have weighed on economic activity. Growth slowed to 3.8 percent in FY2022/23 due to weak confidence and foreign exchange shortages, which constrained overall investment (Figure 1). The health of the non-oil private sector remains frail based on the headline Purchasing Managers’ index, which has been in contractionary territory since 2021. The conflict in Gaza and Israel and the disruptions in the Red Sea are further exacerbating these pressures. Suez Canal revenues, an important source of foreign exchange for Egypt, fell almost 50 percent yoy in January 2024 (a loss of around US$375 million relative to January 2023). Despite a sharp fall in remittances through banks (Figure 2), with foreign exchange being diverted away from the official market, the current account deficit narrowed to 1.2 percent of GDP in FY2022/23 as imports were compressed due to limited foreign exchange availability.

Figure 1.
Figure 1.

Egypt: Contributions to Real GDP Growth

(In percentage points)

Citation: IMF Staff Country Reports 2024, 098; 10.5089/9798400273964.002.A001

Figure 2.
Figure 2.

Egypt: Remittances

(In USD billions)

Citation: IMF Staff Country Reports 2024, 098; 10.5089/9798400273964.002.A001

2. Despite falling back in recent months, inflation remains high. In September 2023, headline urban inflation reached an all-time high of 38 percent, driven by passthrough of the depreciation first of the official exchange rate, and subsequently of the parallel market rate, and shortages of goods related to limited foreign exchange availability. Lending by the Central Bank of Egypt (CBE) to government agencies worth 7.5 percent of GDP, predominantly over the course of 2021 and 2022, and more recently a sharp increase in the Ministry of Finance’s use of the CBE’s overdraft facility beyond the statutory limit both contributed to the loose monetary stance and pressure on the exchange rate. However, headline inflation subsequently declined for four consecutive months, to 29.8 percent in January 2024, driven by a decline in food inflation, largely on account of base effects.

3. The exchange rate was unified in March 2024 as part of a shift to a flexible exchange rate regime and a liberalized FX system. After a sharp depreciation in early-January 2023 following approval of the Extended Fund Facility in December 2022, the official exchange rate remained unchanged since early March 2023 and a large local parallel market premium had persisted prior to unification, albeit narrowing somewhat following the Ras El-Hekma deal (Figure 3). When exchange rate unification began on March 6, the official exchange rate of the Egyptian pound against the U.S. dollar depreciated by 38 percent, closing the spread to the parallel market rate. Prior to unification, limited foreign exchange availability had led to accumulated foreign exchange demand backlogs at banks of US$7-8 billion, which have since been cleared following unification. It has also contributed to the accumulation of external arrears estimated at US$4.5 billion have surfaced at the Egyptian General Petroleum Company (EGPC), which is a public-sector petroleum entity outside of the general government.

Figure 3.
Figure 3.

Egypt: Measures of Market Clearing Exchange Rate and the Official Rate

(EGP per USD)

Citation: IMF Staff Country Reports 2024, 098; 10.5089/9798400273964.002.A001

Figure 4.
Figure 4.

Egypt: Rates

(In percent)

Citation: IMF Staff Country Reports 2024, 098; 10.5089/9798400273964.002.A001

4. Monetary policy has been tightened significantly since early February 2024 to contain inflation and bring real rates towards positive territory. The CBE delivered a 200-bps hike on February 1 and another 600-bps increase on March 6, bringing the main operation rate to 27.75 percent (Figure 4). In addition, the Ministry of Finance’s outstanding balance on the CBE’s overdraft facility has been lowered.

5. Fiscal policy continues to be tightened but debt dynamics are challenging. The overall budget sector deficit narrowed to 5.9 percent of GDP in FY2022/23 from 6.2 percent of GDP in FY2021/22 and performance in the first six months of the FY2023/24 is in line with reaching a primary surplus of 2.5 percent of GDP for the full fiscal year. However, budget sector debt for FY2022/23 increased to about 98 percent of GDP, reflecting the impact of the depreciation and higher interest payments. Over the past 12 months, domestic financing has relied heavily on shortterm Treasury bills (T-bills), private placements of T-bills, Treasury bonds (T-bonds), and Ministry of Finance notes—primarily absorbed by domestic banks—, and borrowing thorough the CBE’s overdraft facility.

6. While the overall health of the financial system remains solid, banks have become more vulnerable. Available data on key ratios (Table 9) through September 2023 suggests the overall banking system’s financial health is sound. However, the capital adequacy ratios of some banks have declined, in part reflecting the impact of the depreciation of the Egyptian pound since March 2022, which has inflated risk weighted assets. Banks’ net foreign asset (NFA) position continued to weaken reaching close to historic lows (Figure 5). While banks remain compliant with regulatory limits, foreign exchange liabilities balanced by foreign exchange lending, particularly to public sector entities (Figure 6), imply a potential susceptibility to an exchange rate depreciation.

Figure 5.
Figure 5.

Egypt: NFA of Commercial Banks

(In USD billions, last date point: end-December 2023)

Citation: IMF Staff Country Reports 2024, 098; 10.5089/9798400273964.002.A001

Figure 6.
Figure 6.

Egypt: Banks’ FX Loans to Residents

(USD billion)

Citation: IMF Staff Country Reports 2024, 098; 10.5089/9798400273964.002.A001

7. The authorities have sold equity stakes in five companies through January 2024 netting US$1.5 billion in deposits at the central bank so far this fiscal year (Text Table 1). However, overall divestment flows from asset sales, excluding the Ras El-Hekma deal, are lower than initially programmed to date and foreign exchange market uncertainty and spillovers from the conflict in Gaza and Israel have impacted other ongoing divestment deals, with no new deals announced since October.

Text Table 1. Divestments (announced, closed, and anticipated for FY2023/24)

Text Table 1.

Divestments (announced, closed, and anticipated for FY2023/24)

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Source: Egyptian authorities. 1/ The initial transaction is a capital increase of US$620 million, with another capital increase of US$80 million by May 2024, which will bring the divested amount to 51 percent. 2/ CBE guarantees a rate of return of 8 percent after 4 years. 3/ USD was deposited at the National Bank of Egypt rather than the CBE. 4/ Estimated sale value; tranasaction preparation well advanced. EGX = Egyptian Stock Exchange; SFE = Sovereign Fund for Egypt.

8. Egypt announced in late February a US$35 billion investment deal with ADQ, an Abu Dhabi-based investment and holding company. The deal has the following components: ADQ will provide US$24 billion in new financing to Egypt (specifically, to the New Urban Communities Authority (NUCA), an Egyptian state-owned entity affiliated to the Ministry of Housing, Utilities, & Urban Communities) to acquire the development rights for the Ras El-Hekma region along Egypt's Mediterranean coast.1 ADQ plans to develop Ras El-Hekma into a holiday destination, financial center, and freezone. Work is expected to commence in early 2025. The Egyptian government will retain a 35 percent stake in the development project, which the authorities estimate may generate US$150 billion in investment in the medium term. As part of the deal, the UAE will convert existing dollar-denominated deposits at the CBE of about US$11 billion into local currency deposits for future investments across Egypt.

Outlook and Risks

9. The macroeconomic projections reflect recent developments, including the exchange rate unification and monetary policy tightening.

  • Real growth for FY2023/24 is projected to slow to 3.0 percent reflecting the impact of FX shortages on private sector activity prior to unification and the conflict in Gaza and Israel, as well as an anticipated decline in external receipts due to disruptions in the Red Sea. A recovery is anticipated in FY2024/25, assuming pressures from the conflict and Red Sea disruptions abate, and as conditions in the foreign exchange market improve. Over the medium term, growth is projected to increase to around 5/ percent, as structural reforms to strengthen the business climate take hold and the state footprint is gradually replaced with private activity. Headline urban inflation is projected to increase in the months following unification, as the depreciation of the official exchange rate passes through to prices, before falling over the medium term toward the CBE's target as base effects unwind and policy tightening takes hold.

  • The framework incorporates the anticipated receipt of US$24 billion in new financing from the Ras El-Hekma investment deal in FY2023/24 as well as the conversion of existing UAE dollar deposits at the CBE into local currency. From the new financing, US$15 billion is sold by NUCA to the CBE and is captured in international reserves, while US$6 billion is assumed to be sold by NUCA to the banking system and this will facilitate the clearance of arrears. The Ministry of Finance will receive the local currency equivalent of US$12 billion from the transaction and this will be recorded in the primary balance, reducing debt by the same amount. These flows are embedded in the respective program targets. The economic implications of the development of the Ras El-Hekma region, which is expected to commence in early 2025, including the potential impact on imports, new FDI, and growth will be incorporated more fully into the macroeconomic framework once there is greater clarity on the medium-term investment program.2

  • While half of the new financing from the Ras El-Hekma deal is applied to debt reduction, the large depreciation at the time of unification and the increase in the policy rate leads to a temporary increase in the debt-to-GDP ratio in FY2023/24. The debt ratio is projected to follow a downward trajectory after FY2024/25, with divestment (assumed to be larger than the projections at the time of program approval by 0.5 percent of GDP each fiscal year starting in FY2024/25), sustained primary balance surpluses (now reaching 5 percent of GDP by FY2026/27), and favorable interest-growth differentials.3, 4

10. Risks to the program are significant. Chief among them would be a failure to sustain the shift to a liberalized foreign exchange system, monetary policy being too loose to bring inflation down, or a failure to deliver a transparent and comprehensive integration of the off-budget investment program into overall macroeconomic policy decision making. Other risks arise from failure to fully implement the supporting policy package: (i) failure to execute the divestment strategy, build buffers from the Ras El-Hekma deal, address payment delays to international oil companies, and demonstrate early intent to meaningfully reducing the role of the state in the economy would continue to keep investors on the sidelines and put additional pressure on the external position; and (ii) delays in boosting tax revenue, implementing the fuel pricing formula, and generating divestment proceeds for debt reduction would further limit fiscal space and increase debt vulnerability. A larger-than-expected exchange rate depreciation, weaker growth, and higher interest rates would also increase sovereign risks. Intensification of regional conflicts and continued disruption in the Red Sea could further undermine growth and the external position, while prolonged inflationary pressures would hurt the vulnerable. On the upside, external financial market conditions for Egypt could ease more than expected and large capital inflows could return. Markets have responded positively to the announcement of the Ras El-Hekma deal and the unification of the exchange rate, with the spread on Egypt's sovereign bonds tightening by almost 300 bps since the deal was announced. A significant increase in foreign direct investment associated with the deal is an upside risk to the growth outlook. Should they materialize, managing large capital inflows prudently will be important to contain inflationary pressures and limit future external vulnerabilities. Inflation could also fall back more quickly than projected, particularly if prices of more goods and services than assumed had already fully adjusted to the parallel market rate that prevailed prior to unification or if a return of confidence results in a material appreciation of the exchange rate. Annex I contains the Risk Assessment Matrix.

Program Performance

11. Program performance relative to the quantitative targets was mixed (Table 13). Under the combined reviews, the targets for end-June 2023 are controlling. The authorities met the quantitative performance criterion for the primary balance for end-June 2023 and the continuous performance criteria on non-accumulation of external arrears by the general government and the prohibition on the imposition or intensification/modification of exchange restrictions, multiple currency practices, and import restrictions. However, the net international reserve (NIR) criterion was missed. The underperformance is explained to a significant extent by a decline in international oil prices, the diversion of some domestic natural gas production away from exports towards domestic consumption, and a lack of portfolio and remittance flows, the latter two likely reflecting concerns about the future exchange rate path after the official exchange rate became fixed in February 2023.5 Corrective actions to strengthen the program significantly, including a shift to a flexible exchange rate regime and a liberalized foreign exchange system, tightening of monetary and fiscal policies, implementation of planned divestments, and program financing ensure that future NIR targets remain achievable. The authorities have also undertaken the required Monetary Policy Consultation after annual urban inflation exceeded the upper outer band under the program. (Annex IV). Commercial banks' NFAs decreased by more than US$2 billion over a three-month period, triggering a consultation with staff. The increased flexibility of the exchange rate should help contain further NFA deterioration. Turning to the indicative targets, the authorities overperformed on the indicative target on tax revenue and social spending for end-June 2023. The indicative targets on the budget sector debt and the maturity of new domestic debt issuances were missed for end-June 2023, the latter due to the skewing of issuance to short-term bills and notes as the authorities sought to limit the increase in the nominal interest bill and to prevent locking-in high interest rates.

12. The authorities met 7 of 15 structural benchmarks (Table 15). The authorities (i) repealed the required use of Letters of Credit, although the repeal failed to fulfill its intended objective of removing an instrument for rationing import demand, (ii) published a state-ownership policy, (iii) amended aspects of the competition law governing M&As (although the executive regulation governing their implementation is yet to be approved by Cabinet), (iv) expanded the number of households eligible for social assistance, (v) identified tax policy measures for the FY2023/24 budget, (vi) abstained from granting exemptions for commercial banks that breach net FX open position limits and (vii) refrained from introducing subsidized lending schemes through the CBE. The authorities published the CAO's audits of the fiscal accounts on time but have not introduced a binding requirement to publish annual fiscal audits regularly. All missed structural benchmarks have been reset with the exception of one on release times at the ports and another on conversion of land records to an electronic register as they are no longer critical for the Fund supported program and the removal of which allows space in the program's structural conditionality for more pressing priorities.

Policy Discussions

The program objectives remain unchanged from program approval. The program aims to sustainably address macroeconomic vulnerabilities and promote inclusive and private sector-led growth. While recent developments shifted the immediate focus to macroeconomic stabilization, the authorities remain cognizant that significant progress on structural reforms is critical to tackle longstanding fiscal and external vulnerabilities as well as to strengthen Egypt’s resilience and medium-term growth prospects. Going forward, key policy objectives under the program include sustaining a flexible exchange rate regime and a liberalized foreign exchange system, reducing inflation, reducing debt, building buffers to withstand future shocks, containing fiscal pressures including those emanating from large national infrastructure projects, and reducing the state’s footprint in the economy by delivering a business environment where the private sector can compete on equal terms with state entities. The updated Memorandum of Economic and Financial Polices (MEFP) reflects the authorities’ continued commitment to these objectives.

A. Monetary and Exchange Rate Policies

13. The authorities have unified the exchange rate and embarked on a shift to a flexible exchange (FX) rate regime and a liberalized FX system. Specifically, the authorities unified the exchange rate (i.e., essentially closed the gap between the official rate and the local parallel market rate) and issued a circular that mandates banks to cancel FX requests if clients do not accept prevailing market exchange rates. A shift to a flexible exchange rate regime and a liberalized FX system is a prior action that has not yet been met. Staff will issue a supplement before the Board meeting to provide an update on this. This measure is assessed using a comprehensive set of indicators: (i) demand backlogs at banks have been cleared; (ii) the spread between the official rate and measures of market clearing rate has essentially closed; and (iii) interbank FX turnover has increased relative to the pre-unification period. Going forward, these indicators will continue to serve as transparent evidence of a sustained shift to a flexible exchange rate regime and a liberalized FX system (structural benchmark). The structural benchmark will be assessed once for each program review, based on information over a period of time between program reviews. In the consultation with IMF staff, the authorities attributed part of the decline in commercial banks' NFA in 2023 to portfolio outflows in early 2023. The shift to a flexible exchange rate should mitigate against further declines; the authorities will continue to consult with staff if banks' NFA at the aggregate level decline by a cumulative US$2 billion over a three-month period.

14. The program allows for some foreign exchange market intervention (FXI) following unification. In the two layers of FXI described below, the authorities committed to conduct the FXI through mechanisms that satisfy three criteria: (i) all intermediaries have access to the mechanism; (ii) no constraints should be placed on bid prices; and (iii) the CBE should make FX allotment solely on the basis of bid prices.

  • Immediate aftermath of unification. To address disorderly exchange rate movements immediately after the unification, scope for limited FXI was provided in the 48 hours following the unification. However, the authorities did not intervene in the market during this period.

  • Existing FXI framework under the program. The program's existing intervention framework would continue to be available for the CBE. The NIR target in the program will be adjusted for interventions within this framework.

  • Reporting on FXI. For both layers of FXI, the CBE will report to the Fund the full array of bids, both prices and volumes on the day of intervention. The CBE would also publish on its website: offered volume by CBE, total volume of bids, total volume of accepted bids, cut-off price for accepted bids, and the weighted average price for accepted bids by the end of the day of the intervention.

15. Monetary policy has been tightened significantly to contain inflation. Although the authorities viewed supply-side issues as a key contributing factor to high inflation and inflation had fallen back since September 2023, they recognized the importance of further tightening policy to anchor inflation expectations, particularly given the possible inflationary impact of exchange rate unification. Since February 2024, the CBE has increased policy rates by 800 bps (prior action), bringing the main operation rate to 27.75 percent. While assessing the overall monetary stance is impeded by limited data on inflation expectations, the authorities viewed this move as sufficient to bring the forward-looking real interest rate into positive territory. The authorities committed to taking a data-dependent approach going forward, expressing their resolve to tighten further if necessary. To support this approach, the authorities have stated their intention to track a wide range of indicators on economic activity, money and credit growth, financial conditions, and price pressures. In addition, the authorities are committed to sterilizing the injection of EGP-liquidity associated with the Ras El-Hekma deal, both from foreign exchange purchases and from the conversion of dollar deposits at the CBE into local currency.

16. This tightening stance is complemented by measures to curtail the size of the CBE’s balance sheet. Rapid expansion of net domestic assets of the CBE between mid-2022 and early-2024, driven by lending to public agencies excluding the Ministry of Finance and, more recently, a sharp increase in the Ministry of Finance's use of the overdraft facility, contributed to the inflation and exchange rate pressures experienced over this period. Cognizant of this, the authorities are committed to maintaining the balance of the government's overdraft account at the CBE within the statutory limit (performance criterion) and preventing further CBE lending to public agencies excluding the Ministry of Finance (performance criterion). The authorities are also committed to developing a plan to reduce claims on public sector agencies excluding the Ministry of Finance to zero over the medium term (structural benchmark).

17. Measures to strengthen the transmission mechanism should increase the efficacy of monetary policy. CBE policy decisions have transmitted effectively to interbank rates since the start of the program, with the overnight rate remaining within the corridor of the deposit rate and lending rate, albeit towards the lower end. To further strengthen transmission, the CBE plans to move to a fixed-rate full-allotment auction for its 7-day deposit operations (structural benchmark). The CBE will also continue to refrain from extending, renewing, or introducing any subsidized lending schemes (structural benchmark) to ensure that policy rates transmit through to bank lending rates.

B. Fiscal Policy

18. The FY2023/24 budget targets a primary surplus of 2.5 percent of GDP, inclusive of expected divestment inflows. This represents a tightening of 0.4 percent of GDP relative to the initial program projection and a tightening of 0.9 percent of GDP compared to the primary surplus for FY2022/23. A projected primary expenditure reduction of 0.6 percent of GDP is the main driver of the tightening relative to the FY2022/23 outturn, while tax revenue is projected to increase by only 0.2 percent of GDP, due to the reduction of tax revenue from the Suez Canal Authority following disruptions in the Red Sea. In addition, non-tax revenue is projected to decline by 0.2 percent of GDP, reflecting lower Suez Canal dividends. Anticipated proceeds from planned divestment of state-owned assets also contribute 0.4 percent of GDP to the increase in the primary surplus. In addition, the MOF will secure local currency equivalent of US$12 billion in proceeds from new financing inflows related to the future development of the Ras El-Hekma region, which will boost the primary balance by 4.6 percent of GDP and reduce debt by the same amount. This one-off windfall will bring the surplus to 7.1 percent of GDP for FY2023/24.6

19. A more ambitious mediumterm primary surplus relative to the initial program is required to place debt more firmly on a downward trajectory. Staff assesses public debt as sustainable but not with high probability, and the overall risk of sovereign stress as high (Annex II). The authorities plan to increase the primary surplus to 5.0 percent of GDP by FY2026/27, excluding divestment proceeds, primarily through tax mobilization, which, compared to peers, is very low (Figure 7 and Text Table 2). To signal their strong commitment to this strategy, the cabinet plans to approve the draft budget law for FY2024/25 with a primary surplus target of 3.5 percent of GDP excluding expected divestment flows, underpinned by an increase of tax and dividend revenue of 1.0 percent of GDP in FY2024/25 (prior action). In addition, the authorities plan to transfer 1.0 percent of GDP of divestment proceeds to the treasury to reduce public debt in FY2024/25. Moreover, the cabinet will submit to parliament an amendment to the VAT law that will simplify the VAT, reduce exemptions, and enhance its efficiency and progressivity by November 2024 (structural benchmark). This reform will yield 1.0 percent of GDP tax revenue beginning in FY2024/25.

Figure 7.
Figure 7.

Egypt: General Government Taxes

(In Percent of GDP, 2023)

Citation: IMF Staff Country Reports 2024, 098; 10.5089/9798400273964.002.A001

Text Table 2.

Decomposition of Fiscal Consolidation

(In percent of GDP)

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1/ The MOF will secure US$12bn from the Ras El-Hekma investment deal to reduce public debt, which is estimated at 4.6 percent of GDP in addition to another 0.4 percent of GDP divestment proceeds from other sales of state assets. Source: MOF and IMF staff caclulation

20. To anchor the medium-term revenue mobilization effort, the authorities are preparing a tax policy strategy document. The strategy will complement the continuing efforts to improve tax administration and underpin the target to increase tax-to-GDP by 3 percentage points by FY2026/27 (Text Table 3). Envisaged tax policy reforms will include the VAT reform mentioned above and passing a new Income Tax Law, which has been prepared with IMF Technical Assistance to strengthen income tax collection. Other contemplated tax policy measures include: adopting a carbon tax to support emissions reduction and in light of the implementation of the EU's Carbon Border Adjustment Mechanism; adopting a withholding tax on the turnover of exports from freezones in Egypt to the domestic market; and participating the OECD's Automatic Exchange of Information. In addition, the authorities will undertake a detailed assessment of the economic benefits of the current freezones by end-September 2024 (structural benchmark) and limit any further expansion of freezones until this assessment is conducted.

Text Table 3.

Tax Measures 1/

(In percent of GDP)

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Source: MOF and IMF staff estimation 1/ The cumulative increase in tax revenue from identified measures is 4.2 percent of GDP. However, the net projected increase in tax revenue is 3.0 percent because taxes on interest earnings decrease over the projection period with the anticipated decline in interest rates on government securities.

21. The authorities will continue adjusting energy prices to reign in unaffordable energy subsidies and create fiscal space for enhancing targeted social transfers. Fuel subsidies have increased due to exchange rate depreciation and a failure to fully implement the quarterly automatic fuel price mechanism (recurring structural benchmark). To lower untargeted fuel subsidies, the authorities committed to increase the price of gasoline grade fuels to the level implied by the formula, including catch-up from the failure to fully implement the January 2023, April 2023, July 2023, and October 2023 adjustments (prior action). The authorities will also develop a plan to adjust diesel prices to be fully in line with the level implied by the full implementation of the formula since the start of the program.

22. Social protection has been strengthened since the start of the EFF-supported program. The authorities have expanded the coverage of the Takaful and Karama cash transfer program to more than 5 million households and increased the average monthly payments by 15 percent in FY2022/23. To offset the impact of elevated inflation on vulnerable groups, the authorities have raised the minimum public sector wage from EGP 3,000 to EGP 6,000, increased public sector wages, and topped up allowances for almost 2 million teachers and 0.6 million doctors and health experts. The authorities are also strengthening the social registry and improving the targeting of food subsidies. To underline their commitment to protecting social expenditures while aggressively tightening the overall budget, the authorities will maintain a floor of social spending under the program (indicative target).

Text Table 4.

Public Investment

(EGP billions, unless otherwise noted)

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Source: Ministry of Planning and Economic Development, Ministry of Finance and IMF staff calculations 1/ Total investment is published by the Ministry of Economic Planning and components are provided by the authorities. 2/ For the budget columns, the applicable GDP level is the one used by the authorities for budgeting purposes. For FY23/24, investment relative to current projections of GDP would be around 7.5 percent of GDP.

23. Significant steps are being taken to better monitor and control on- and off-budget public sector investment. The Prime Minister issued a decree that requires all public entities to report annual projected and executed investment spending, including projects contracted or undertaken by entities such as the Administrative Capital Urban Development (ACUD) and the Armed Forces Engineering Authority and its affiliates, to a cabinet level committee chaired by the Central Auditing Organization (CAO). The decree specifies that the target ceiling on the value of total public investment (including the budget sector) over the period from January - June 2024 is EGP 350 billion and the target for FY2024/25 is EGP 1,000 billion, which will achieve a real reduction in total public investment under the baseline to ease demand pressures. These targets will be monitored under the program through a new indicative target with semi-annual reporting. Based on available information, the target implies a real tightening of total public investment in FY2024/25 relative to FY2023/24 as the agreed target is broadly equivalent to budgeted investment for FY2023/24, which did not capture most spending on megaprojects (Text Table 4). In the near term, the authorities will cut funding for budget sector investment in the second half of FY2023/24 by 15 percent relative to the prior year and have postponed any new budget sector projects.

24. The authorities are redoubling their efforts to strengthen the management of fiscal risks and improve fiscal transparency. To further strengthen the control of fiscal risks from off-budget activity, the authorities will ensure that the stock of government guarantees relative to GDP, which were 22 percent of GDP at end-September 2023, will stabilize for the remainder of the current fiscal year at their end-September 2023 level and decline as a percent of GDP starting from end-June 2024 (indicative target). In addition, 59 Economic Authorities will be gradually incorporated into general government fiscal reporting and subject to binding ceilings on their debt in the annual budget law, adjustment of which will require parliamentary approval. A sector classification of the Economic Authorities will be conducted in accordance with the concepts and principles in the GFSM 2014 (structural benchmark). To enhance fiscal transparency and improve budget operations, the authorities will publish an annual fiscal risk statement as part of the budget documentation, starting from FY2024/25 in line with IMF technical assistance. The authorities have also recommitted to fulfill the existing unmet fiscal structural benchmarks related to publication of the following reports: monthly procurement activity, the annual audits of fiscal accounts, tax expenditures, budget sector arrears, and the new PFM regulations.

25. The Egyptian General Petroleum Company (EGPC) has accumulated arrears to international oil companies. The arrears are reported at US$4-5 billion. They have accumulated due to foreign exchange shortages and several structural factors, including reduced domestic production of gas and higher domestic consumption reducing the scope for gas exports, and increased subsidies from EGPC to the electricity sector. While the outstanding claims, which are in US dollars, are not guaranteed by the general government and will be paid by EGPC, a ministerial decree has established a committee for negotiating deferral agreements with all suppliers. The repayment strategy will seek to ensure that no new arrears are accumulated, and existing arrears will be cleared (structural benchmark). The foreign exchange liquidity provision in the interbank market noted above can help facilitate the timely clearance of the arrears.

26. To complement the stronger fiscal consolidation effort, the authorities are adjusting their financing and debt management strategy to reduce debt and gross financing needs, in addition to half of the new financing from the Ras El-Hekma investment deal being allocated to debt reduction, starting with reducing the overdraft balance at the CBE. In particular:

  • Gradually extending the issuance maturity of domestic debt as financing conditions improve, namely, once the uncertainty around the macro-outlook is addressed resolutely through policy actions (existing indicative target).

  • Debt management measures to extend the maturity of existing domestic debt, while containing interest expense. The authorities have agreed with pension funds and insurance funds to extend the maturity of existing debt that matures in the next several years. The authorities have also agreed with major state banks to issue new three-year T-bonds when the existing T-bonds held by these banks mature in the next several years.

  • Addressing any prospective recapitalization of the CBE in a way to safeguard the balance sheet of the CBE and bolster its ability to deliver on its price stability mandate, while taking into account the government's debt management strategy and the costs related to fair value measurement and impairment upon full compliance with EAS/IFRS (structural benchmark).

  • An improvement in the quality of fiscal financing, though increasing the share of official sector external budget financing and by bringing the government's overdraft account at the CBE gradually under the statutory limit (performance criterion).

C. Financial Sector Policies

27. Despite some recent deterioration in capital adequacy, the financial system appears capable of weathering the initial impact of the unification and monetary tightening. Prior to unification, the banking system's capital adequacy ratio (CAR) had declined relative to 2021 due in part to the impact of the large foreign exchange depreciation on risk-weighted assets. While overall, the system appears adequately capitalized, the drop in the CAR of some banks to close to the regulatory limit raises some concerns. Liquidity indicators point to excess liquidity in the system. On aggregate, banks have a large negative net foreign asset position, but they have remained in compliance with their net open position limits, with FX borrowing from nonresidents offset by FX lending to residents. Bank credit to government and public sector companies has expanded significantly over the past year, with lending to state and local government in foreign currency increasing by over US$8 billion. Banks' increased foreign exchange exposure to these entities could imply higher credit risk, although the authorities noted that banks only lend to entities with reliable sources of foreign exchange to service loans. There could also be liquidity risk in foreign exchange due to maturity mismatches and the limited ability of the CBE to function as a backstop in case of sudden foreign exchange deposit withdrawals. While staff does not have detailed bank data for conducting stress tests, the CBE's regulatory stress tests reportedly point to adequate capital and liquidity buffers under large, combined exchange rate and interest rate shocks. To closely monitor existing and potential risks to the financial sector, the CBE is committed to completing stress tests of the banking sector and sharing detailed results with IMF staff. These tests will be prepared in consultation with IMF staff (structural benchmark).

28. Governance practices, particularly at the state-owned banks, remain concerning. The re-introduction by state-owned banks of high-yield CD with rates that significantly exceeded the prevailing policy rate further underscores that state-owned banks may not be acting at arm's length. This has possible negative implications for the financial health of the banking system and other program objectives such as developing a robust market-based transmission mechanism for monetary policy. While the authorities generally did not share these concerns, the CBE agreed not to issue any new subordinated debt to state-owned banks. Staff will continue to explore avenues to strengthening the independence of state-owned banks.

D. Structural Reform Policies

29. Implementation of the State-Ownership Policy (SOP) will continue to be a key anchor of program reforms going forward. Importantly, the authorities issued in February 2024 an executive regulation implementing the provisions of a law passed in July 2023 that has the objective of eliminating preferential tax treatment and exemptions for state-owned enterprises, including military-owned ones. While immediate macroeconomic pressures dominated the agenda of the combined first and second reviews, commitment to the structural agenda was deepened and strengthened through new structural benchmarks to enhance the transparency of SOE activity and develop an indicator to track progress in implementing the SOP. Specifically, to enhance SOE transparency, which is critical to achieving the program objective to level the playing field, the authorities committed to (i) re-instate regular publication on the appropriate government website of annual aggregate reports on Egypt's SOE portfolio, with coverage expanded to include all state-owned enterprises (structural benchmark); and (ii) include all the procurement opportunities and awards made by the largest 50 state-owned enterprises on the general government's e-tenders site (structural benchmark).

30. The authorities plan to take a more strategic approach to divestment, which will add value and transparency to the process. Divestment is an important mechanism to reduce the state's footprint in economic activity. Going forward, the government plans to take a more strategic approach, based on IFC advice, by pursuing a sector-by-sector approach to divestment, with a focus on large transactions in those sectors that appeal to foreign investors (i.e., assets that generate foreign exchange flows). Adoption of the approach, including preliminary steps to enhance the attractiveness of the sectors and ensure the transactions are appropriately priced and transparent, which will support the further development of competitive markets, will take time. In the interim, the authorities will seek closure on already announced sales and pursue the sale of state assets where the process is well advanced (e.g., sale of windfarms, a power plant, and desalinization plants). Conservatively, the authorities estimate another US$600 - US$700 million in USD flows from further divestments in FY2023/24 is possible, which would bring total USD divestment flows from non-residents in FY2023/24 to about US$2.8 billion, excluding the Ras El-Hekma deal. In FY2024/25, the authorities have identified specific divestment opportunities to generate US$3.6 billion in dollar inflows, plus another 0.5 percent of GDP in additional divestment flows either denominated in EGP or USD.

31. Efforts to strengthen the business climate continue. Following the amendment to the Competition Law in December 2022, the Egypt Competition Authority (ECA) has drafted implementing regulations, which the authorities have committed to issue through a Prime Ministerial decree by end-April 2024. The ECA is also redrafting amendments to the competition law, which were initially submitted to Parliament in 2019 to strengthen the independence of the ECA, to address constitutional concerns about the ability of the ECA to levy fines and other issues such as the ECA's governance structure and will submit the redrafted amendments for Cabinet approval by end-June 2024, which is a new commitment under the program. To get a better insight from market participants on weaknesses in the competitive neutrality framework, the ECA is also creating an index, which will be a perception-based survey asking key stakeholders (e.g., commerce, legal professionals) about tax, capital, regulatory, and public procurement neutrality issues in their sectors. The high-level results from the series will be published and will inform on competitive neutrality issues that need to be addressed.

Extended Fund Facility Program Modalities

32. The program accommodates a larger buildup of reserve buffers against external shocks. Total projected program financing was increased to US$7.8 billion in FY2023/24 and US$28.5 billion for the program period. This will allow for slightly more reserve accumulation at end-FY2023/24 in nominal terms relative to projected levels at program approval, and further increases in reserves against a deterioration of the projected net reserve inflows over the medium term.7 The accelerated and higher reserve accumulation encompasses the CBE's purchase of US$15 billion of the US$24 billion of new financing from the Ras El-Hekma deal. Foreign reserves are projected to further increase over the remainder of the program. (Table 11).

33. The authorities have requested an augmentation of access under the EFF arrangement to support their adjustment effort in response to external shocks and a rephasing of access. The requested augmentation of access is 184.70 percent of quota SDR3,761.52 million (or about US$5 billion). The augmentation would be made available following the completion of the combined 1st and 2nd EFF review, with the purchases under the program divided in line with balance of payments gaps and the augmentation spread over the remainder of the program (Table 12b). Purchases under the EFF arrangement will be used for budget support. To better align access with review cycles under the program, the authorities also requested rephasing the availability date of the purchase associated with the second review to March 15, 2024, and the availability date of the purchase associated with the third review to June 15, 2024. Moreover, the arrangement is no longer subject to the Fund's Exceptional Access procedures as Egypt's exposure, following significant repurchases over the last year, is projected to remain below the normal cumulative access threshold of 600 percent of quota. At the time of program approval, Egypt's exposure was projected to remain above the normal cumulative access limit well into 2023.

34. The Fund-supported program is fully financed. The total financing needed to reach the revised net international reserve targets for FY2023/24 is US$6.2 billion after accounting for US$1.6 billion from the IMF (Table 11). The authorities have secured firm financing commitments for the next 12 months from foreign partners to close the gap and there are good prospects of adequate financing for the reminder of the program period. Assurances have also been received that US$19 billion of official deposits from Arab countries at the CBE will remain at the CBE until after the expiration of the EFF arrangement in September 2026 and will not be used for the purchase of equities or debt. A rebooted divestment strategy, benefiting from stronger governance and oversight from IFC advisory services, would continue to provide external financing, but with a more backloaded profile. With several GCC partners having publicly communicated their support for Egypt's reform program, a substantial pipeline of identified state assets, and with smaller financing gaps in the outer years of the Fund-supported program, staff assesses that there are good prospects for the remainder of the arrangement to be fully financed, including through multilateral support, additional external issuances, potential further support from the EU, and larger policy adjustments if needed.

35. Safeguards assessment. A safeguards assessment of the CBE was completed in April 2023. It found that legislative reforms have enhanced the CBE's legal framework and the CBE has strengthened its audit and risk management processes. However, significant quasi-fiscal (development) lending to public sector agencies excluding the Ministry of Finance, that reached around EGP 765 billion by February 2023, appears to contravene the 2020 CBE Law and compromises the central bank's autonomy and financial position. While underlying details on the beneficiary agencies are yet to be provided by the CBE, the authorities have reported some repayment of the loans, with the stock of lending at EGP 661 billion as of end-January 2024, and have confirmed that the outstanding loans are being serviced at the CBE lending rate. As noted above, the authorities are committed to prohibiting new development lending to public agencies excluding the Ministry of Finance (performance criterion) and will develop a plan to gradually reduce the claims to zero (structural benchmark). The assessment also highlighted the importance of developing a recapitalization plan to safeguard the CBE's financial position. Recognizing this, the authorities are undertaking a comprehensive assessment of the CBE's recapitalization needs and developing a recapitalization plan that considers both the government's debt management strategy and the importance of having an independent and well-capitalized central bank (structural benchmark). This will also need to consider implications of CBE's full compliance with Egyptian Accounting Standards (EAS), an outstanding safeguards recommendation to strengthen transparency and address current deviations in the CBE's financial statements on key aspects, including fair value measurement and disclosures on material balance sheet items, as well as transactions with related parties.

36. The next program review is scheduled on a quarterly basis and program conditionality and reporting requirements have been strengthened to maintain the reform momentum. Quantitative program targets for end-March 2024, end-June 2024, end-December 2024, and indicative targets for end-September 2024 were agreed. The third review is expected to be completed by June 2024 and the fourth review is expected to be completed by December 2024, which will be based on end-March 2024 and the end-June 2024 performance criteria, respectively. In addition to existing performance criteria on net international reserves, the primary balance, and non-accumulation of external debt payment arrears, performance criteria are proposed on the government's overdraft at the CBE and central bank development lending to public sector agencies excluding the Ministry of Finance. New indicative targets are proposed on government guarantees and public investment, including national projects. The monetary policy consultation clause (MPCC) will continue to serve as a means of monitoring the inflation performance and policy stance of the CBE. Reflecting the elevated and volatile nature of inflation at present, the MPCC bands around a central target of 7 percent are set intentionally wide in the near term. The bands narrow over time, reflecting the importance of ensuring policies are sufficiently tight to lower inflation. Moreover, to address some shortcomings in data reporting and improve program monitoring, the data reporting requirements for the program have been enhanced.

37. Enterprise risks are elevated and capacity to repay the Fund is subject to high risks and contingent on full program implementation and the materialization of all projected financing. Egypt is the Fund's third largest exposure in the General Resources Account, which is a potential credit risk concentration. Egypt's total Fund obligations relative to GDP, exports, reserves, and government revenue largely exceed the 75th percentile of comparator countries. Fund credit outstanding as a share of gross reserves is projected to reach 29.5 percent in FY2023/24. Failure of the program resulting from partial implementation of measures to support sustainable growth, reduce debt risks, and mobilize sufficient financing would pose reputational risks for the Fund. Other risks include potential social discontent, a further escalation of regional conflicts that complicates program implementation, and materialization of contingent liabilities. Conversely, failure to complete the review may lead to arrears resulting in loss to the Fund and reputational damage to the Fund in its ability to perform. More broadly, Enterprise risk to the Fund is expected to decline gradually as Egypt's overall exposure will decrease over the medium term.

Staff Appraisal

38. Egypt is facing significant macroeconomic challenges that have become more complex to manage with the recent conflict in Gaza and Israel, even as new large investment inflows have eased near-term financial pressures. The conflict is adversely affecting tourism and could dent foreign direct investment, adding to balance of payments pressures. The disruptions in the Red Sea are also reducing Suez Canal receipts, which are an important source of foreign exchange inflows and fiscal revenue. Policy slippages have also contributed to macroeconomic imbalances. The new investment deal for the development of the Ras El-Hekma region eases current external pressures, and while the actual development of the region could boost growth prospects beyond the assumed baseline, it could also add to future external pressures, if not managed properly.

39. To restore macroeconomic stability, the authorities have significantly strengthened the reform package underlying the EFF-supported program. The recent unification of the exchange rate together with the monetary policy tightening are critical components of the package. Other elements of the package are just as critical, including a sustained shift to a flexible exchange rate regime and a liberalized FX system, the commitments to significantly tighter fiscal and monetary policies, greater transparency and control over off-budget activities, a reformed and expanded divestment program, and accelerated measures to improve the business environment and reduce the state's economic footprint. Steadfast implementation of the strengthened program is imperative to restore macroeconomic stability and investor confidence and manage demand pressures. To this end, the authorities' commitment to use a large part of the new financing from the Ras El-Hekma deal to improve the level of reserves, fast-track the clearance of foreign currency backlogs and arrears, and reduce government debt upfront is prudent.

40. The unification of the exchange rate is a welcome step toward correcting macroeconomic imbalances. Maintaining a flexible exchange rate regime and a liberalized foreign exchange system will be imperative to avoid the buildup of external imbalances in the future. To support this sustained shift to a new FX regime and system, any FXI should be conducted through mechanisms that are market-based, nondiscriminatory, and transparent.

41. Staff also welcomes the measures to significantly tighten monetary policy. The cumulative 800 basis point increase in the policy rate since February will move the real rate toward positive territory and help anchor inflation expectations following exchange rate unification. The commitment to maintaining the balance of the government's overdraft account at the CBE within the statutory limit and preventing further CBE lending to public agencies excluding the Ministry of Finance, as well as sterilizing the injection of EGP-liquidity associated with the Ras El-Hekma deal, should also help ease inflationary pressures. Going forward, monetary policy must focus squarely on reducing inflation and the CBE's resolve to tighten further, if necessary, should help in this regard. The CBE's intention to take a data-dependent approach should be supported by efforts to improve the monitoring of inflationary pressures, including developing measures to track inflation expectations and changes in economic activity at high frequency.

42. The commitment to undertake greater revenue-based fiscal consolidation will sustainably increase the primary surplus and firmly put debt on a downward path. Egypt's tax revenues are very low relative to peers and insufficient to ensure debt sustainability while adequately protecting vulnerable households. The authorities have begun taking steps in this direction. Cabinet approval and the planned submission to parliament of amendments to the VAT law in FY2024/25 represents a firm down payment toward fulfilling their commitments toward achieving higher medium-term primary surpluses under the program. A commitment to limit the expansion of free zones will also help as well as full adherence to the automatic fuel price adjustment mechanism. Adjustments to the financing and debt management strategy complement the effort to reduce debt and gross financing needs.

43. The commitment to improve monitoring and control of a broader perimeter of public sector expenditures strengthens the policy package relative to program approval. National public-sector led projects are a major contributor to internal and external imbalances. The Prime Ministerial decree requiring the establishment of a framework for monitoring and controlling overall public investment, including by Economic authorities and military-owned entities, is welcome as are the authorities' commitments to limit the granting of guarantees by the Ministry of Finance and measures to expand the perimeter of fiscal reporting.

44. With policies to restore macroeconomic stability in place, the stage is set for more aggressive implementation of the structural reform agenda. While some notable divestments were announced in early FY2023/24, the divestment program subsequently slowed. The unification of the exchange rate and implementation of tighter monetary and fiscal policies coupled with advice from the IFC provides fertile ground to move aggressively forward with the divestment program. In addition, the stage is set for a more convincing effort to start withdrawing the state and military from economic activity and leveling the playing field across economic agents are critical to securing investor confidence and releasing constraints to private activity. Moreover, steps toward improving competition in the banking sector will be important.

45. Risks to the program stem from the need to stay the course on difficult policy adjustments in a shock prone environment. The shift to a flexible exchange rate regime and a liberalized FX system would need to be sustained. Similarly, fiscal consolidation in the context of rising living costs could face political and social pushback. The proposed structural reforms will take time to implement and deliver the intended results while reforms aimed at reducing the role of the state may face resistance from vested interests in the country. Frequent external shocks could test the authorities' commitment and ability to sustain the reforms. The ability to assess program performance hinges on the authorities' commitment to meet the significantly strengthened reporting requirements under the program on a timely basis. A temporary shift to a quarterly monitoring cycle and consultations with the public by the authorities on the objectives of the reform program as well as support for the program at the highest political level are important risk mitigating factors.

46. Staff supports the authorities’ requests for a waiver of the missed June 2023 QPC on NIR, augmentation of access, rephasing of disbursements, and recommends completion of the MPCC consultation with the Executive Board. Staff supports the request for the waiver of nonobservance due to the corrective actions taken by the authorities. Importantly, the augmentation will facilitate accumulating buffers against the backdrop of highly uncertain, adverse, and continuing economic effects of conflicts to help secure stability. The attached LOI and MEFP present a strong set of policies and the authorities' commitment to pursue the objectives of the strengthened Fund-supported program.

Table 1.

Egypt: Selected Macroeconomic Indicators, 2019/20-2028/29 1/

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Sources: Egyptian authorities; and IMF staff estimates and projections. 1/ Fiscal year ends June 30. 2/ General government includes the budget sector, the National Investment Bank (NIB), and social insurance funds. 3/ As defined in the program. 4/ Ministry of Finance financial statements audited by the State Audit Agency in line with the Government Accounting Law. 5/ Budget sector comprises central government, local governments, and some public corporations. 6/ Accrued interest expense is not included in the overall balance through FY2022/23 as per the authorities' presentation, while it is included in the overall balance from FY2023/24 onwards as in GFSM 2014. 7/ Includes multilateral and bilateral public sector borrowing, private borrowing and prospective financing. 8/ Debt at remaining maturity and stock of foreign holding of T-bills.
Table 2a.

Egypt: Balance of Payments, 2019/20-2028/29

(In billions of US$, unless otherwise indicated)

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Sources: Central Bank of Egypt; and IMF staff estimates and projections. 1/ Includes foreign official creditors' deposits at the CBE and the 2021 SDR allocation. 2/ This line includes changes in gold valuation and a statistical correction for program purposes, eliminates transfers from Tier 1 to Tier 2 from errors and omissions. 3/ End of period.
Table 2b.

Egypt: Balance of Payments, 2019/20-2028/29

(In percent of GDP, unless otherwise indicated)

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Sources: Central Bank of Egypt; and IMF staff estimates and projections. 1/ Includes foreign official creditors' deposits at the CBE and the 2021 SDR allocation. 2/ This line includes changes in gold valuation and a statistical correction for program purposes, eliminates transfers from Tier 1 to Tier 2 from errors and omissions. 3/ End of period.
Table 3a.

Egypt: Budget Sector Operations, 2019/20-2028/29 1/

(In billions of Egyptian pounds, unless otherwise indicated)

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Sources: Ministry of Finance; and IMF staff estimates. 1/ Budget sector comprises central and local governments, and some public corporations. Fiscal year ends June 30. Cash basis. 2/ Through FY2022/23, data is shown as per the authorities' presentation, whereby interest does not include accrued interest expense on T-bills and zero coupon bonds, which is instead included in non-deficit debt creating flows. Beginning in FY2023/24, interest is defined as in GFSM 2014, and it includes accrued interest expense. Accrued interest expense is not included in the overall balance through FY2022/23, while it is included in the overall balance beginning in FY2023/24. 3/ Food subsidies include subsidies paid to farmers. 4/ Increased transfers to the SIF starting in 2020/21 reflect impact of pension reform approved in 2019/20. 5/ As defined in the program. 6/ Ministry of Finance financial statements audited by the State Audit Agency in line with the Government Accounting Law. 7/ Difference between gross debt (authorities' financial statement basis) and budget sector deposits with commercial banks.