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How to make LE89 bn in fuel subsidies disappear: Egyptians brace for steep price hikes
 
 
Photograph: Osman El Sharnoubi
 

A sense of wariness overtakes many Egyptians from April to July each year, the three months in which Parliament discusses the upcoming state budget and makes decisions which may affect large swaths of the population. This year, that general worry about potential cuts is less undefined, as Egyptians are buckling up for an imminent hike in fuel prices.

Public attention to the subsidy allocations stipulated in the annual state budget has increased in recent years, since the government imposed an austerity program in 2014, which included subsidy cuts and new consumption taxes, in an effort to rein in the state’s growing budget deficit.

This year is likely to see steeper hikes in fuel prices than those seen in years past, as the government’s structural adjustment program, approved by the International Monetary Fund (IMF) in November 2016, comes to an end. Liberalizing fuel prices before the close of 2019 was one of the several terms of the three-year program, which must be met to ensure the continued dispersal of the IMF’s US$12 billion loan to the Egyptian government.

However, the structural adjustment program, which introduced a host of other measures with inflationary repercussions, got off to a rough start. Once the exchange rate was floated on November 3, 2016, the value of the Egyptian pound fell more than originally projected. This resulted in a significant rise in the nominal value of fuel subsidies in the state’s budget for the two fiscal years following the IMF agreement. While the nominal value of fuel subsidy allocations in the state budget seems to have drifted away from the targets initially stipulated in the agreement, documents released by the IMF after its second review of the program’s implementation at the close of 2017 show that the government remains determined to achieve the 2019 target of lifting fuel subsidies altogether.

The allocations for fuel subsidies in the upcoming state budget for fiscal year 2018/19 were set by the government at LE89.075 billion, according to an official document obtained by Mada Masr. While this indicates a decrease in the nominal allocation toward fuel subsidies for the first time since the pound was floated, there still remains a large amount to be drastically cut before the end of 2019.

This creates a dilemma for the government, which now faces one of two choices. It can significantly raise fuel prices in just one year, thereby meeting the IMF’s target, albeit at the expense of many Egyptians’ livelihoods. Or, it can fail to meet the target of liberalizing fuel prices.

Source: Ministry of Finance
*LE115 billion is the preliminary spending estimates, according to the updated financial statement
**LE120 billion is the expected value for fuel subsidies in FY 2017/18 financial statement according to a copy of the draft budget obtained by Mada Masr.

As prices increased so did the fuel subsidy bill

Since 2011, when Egypt entered an economic crisis as post-January revolution political turmoil and sporadic violence drove away tourists and deterred foreign investors from returning to Egypt’s debut market, factors that caused foreign currency reserves to plunge to dangerous levels, the decision to restructure the state budget by cutting subsidies and raising taxes had been deferred by a series of successive governments. Following four years of talks with the IMF and a prolonged period of political turbulence, President Abdel Fattah al-Sisi ordered the first hike in fuel prices in June 2014, one of his first measures after taking office. The decision was followed by the first surge in inflation, which reduced people’s ability to purchase goods and services.

While this initial wave of inflation would soon prove to be the mildest rise in the prices of goods and services since the government implemented its austerity program in 2014, there was a temporary relief. During the first two years of the program, Egypt benefited from a plunge in international oil prices, which allowed to government to forego price increases in FY 2015/16, all the while enjoying a smaller subsidy bill in the budget.

However, when Egypt sealed an agreement with the IMF in November 2016 facilitating the provision of a US$12 billion loan to be disbursed over three years, another round of fuel price hikes was implemented and the exchange rate was liberalized. A lower than anticipated value of the pound increased the cost of oil in the budget. In turn, the government failed to meet the IMF’s targets. During its late 2017 review, the IMF offered the government waivers on the targets related to the cost of fuel subsidies.

Source: Statements by Ministry of Petroleum

In addition to the influence of the international market, the government’s inability to reduce its subsidy bill was also caused by its decision to keep prices for producers fixed and raise prices on end consumers, according to Salma Hussein, a researcher at the Egyptian Initiative for Personal Rights (EIPR). “Tourism companies, factories and commercial services all benefit from a very generous undeclared subsidy,” she says.

The last time the government published the distribution of subsidy allocations over different types of fuel was in FY 2014/15. Since then, the government has only released the total cost of fuel subsidies, without specifying how much goes to end consumers and how much of goes toward producers.

According to the draft of the upcoming budget, of which Mada Masr has obtained a copy, the fuel subsidy bill for the current fiscal year is expected to close at LE120 billion, missing the target set during the late 2017 IMF review, which supposedly took into account the unexpected drop in the value of the pound. The IMF’s currency projections were further askew, however, as an appreciation of the Egyptian pound to LE16 per $1, the assumption upon which the budget for the current fiscal year was drafted, never occurred, says Omar al-Shenety, managing director at the Cairo and Dubai-based investment bank Multiples Group. The value of the pound per US dollar hovered around LE17 throughout the year.

Coupled with the rising fuel subsidy bill, the government’s assertion that it would meet its 2019 target to lift subsidies, which it reaffirmed during the IMF’s second review of the economic reform program, leaves only one possible path for the Egyptian government: a steep increase in the price of fuel for consumers. Will the government make people pay for its incorrect projections?

What to expect in the coming months

For the government to adhere to the IMF deal’s timeline, fuel prices would need to be increased drastically, probably over three rounds during the next 18 months, with an average price hike of 30 to 35 percent each time, says Shenety.

“It is likely this will be the scenario, because it is obvious that this is part of the agreement with the IMF, and there is no room for backing down,” says Shenety.

In the managing director’s estimation, diesel and 80-octane gasoline would see the largest price increases, as they receive the largest subsidy allocation.

Drastic cuts to these heavily subsidized fuels will place the burden of price increases on Egyptian households, as the transportation of people, goods and services is highly reliant on these types of fuel, according to Hussein.

If fuel prices were to be completely liberalized in one year, the impact on people would be “severe,” says the EIPR researcher, who finds it unlikely that the government will be able to lift fuel subsidies in such a tight timeframe.

“First, the figure of the subsidy [bill] is very high for [the government] to be able to completely lift it in one year, as this would require a massive jump [in prices],” says Hussein. If this does occur, “it would be a shock, rather than a gradual cut, as previously announced.”

Source: International Monetary Fund
*EFF stands for Extended Fund Facility, which is the program agreed to by Egypt and the IMF

What next?

In the 2016 agreement, the IMF set another target for the government: to conceive of a formula with which to calculate domestic prices such that they reflect international market rates once the subsidies are lifted. The agreement refers to this process as an “automatic fuel price indexation mechanism.”

This mechanism will allow the government to link domestic fuel prices to international prices, explains Hussein.

According to Shenety, there are two ways to liberalize fuel prices. The first would be a direct reflection of international prices, whereby fuel prices would change on a daily basis. However, “this would likely lead to a large fluctuation in prices.”

The second scenario, which he says is more likely for Egypt, would be to use a formula that allows the government to fix fuel prices for a set period of time, while simultaneously accounting for international market fluctuations. Any divergence from the fixed price during one period would be folded into the price of the next period, to ensure that the budget does not incur subsidy costs. The values in this formula would then be reviewed periodically.

The government “committed to implement the next fuel price increase and the indexation mechanism by December 2018,” according to the IMF staff report published in January, after the second review. However, “the exact timing of implementing the indexation mechanism will be discussed at the time of the third program review.” A delegation from the IMF is expected to visit Egypt in May to undertake the third progress review for the program.

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