2 years after the loan agreement: What the IMF failed to anticipate

On November 11, 2016, the International Monetary Fund (IMF) and the Egyptian government finalized a US$12 billion loan agreement tied to an economic reform plan that included a series of austerity measures and the liberalization of the Egyptian pound.

At the time, Egypt was facing a shortage in foreign currency reserves, and both the IMF and the Egyptian authorities made optimistic forecasts about the future of the Egyptian economy under the new economic program.

Two years later, the crisis in foreign currency reserves has largely been alleviated and the IMF’s growth targets appear to be on track. Yet those achievements have been offset by soaring rates of inflation and foreign debt, along with the plummeting purchasing power of the local currency. Meanwhile, fuel subsidies, which were meant to be reduced to alleviate the government budget — a specific goal of the economic program — have instead increased as a result of the devaluation of the pound.

A number of these unanticipated challenges now facing the Egyptian economy are highlighted in a new report by the investment bank Shuaa Capital, which was issued to its clients several days ago and of which Mada Masr has obtained a copy.

Clear but unbalanced growth

The gross domestic product (GDP) growth rate has clearly improved in the two years since the IMF loan, rising from 4.3 percent prior to the agreement to a projected 5.8 percent in June 2019, which will mark the end of the three-year fiscal period of the deal.

However, according to Shuaa’s report, these high GDP growth rates conceal a lack of “balance.”

While private sector investments in areas other than oil, gas, construction and real estate were beset by considerable challenges prior to the implementation of the economic reform plan, this was primarily due to foreign currency shortages, and these challenges were eventually alleviated.

However, the private sector has also suffered in the period following the agreement because of the rise in energy prices, the increase in the price of raw materials after the currency devaluation and the significant increase in the cost of credit due to rising interest rates, the report says.

The prospect of a decrease in the cost of credit seems unlikely to occur in the near future. When the loan agreement was announced, the IMF said that “monetary policy will focus on containing inflation and bringing it down to mid-single digits over the medium term.” This goal effectively entails significant increases in interest rates, which are not expected to decline anytime soon.

“Despite the slow down in core inflation (which excludes the effects of fluctuating commodities and those that are subject to government pricing), it is unlikely to be an incentive for the Central Bank to cut core interest rates in the short term,” the Shuaa report details.

With the exception of the oil and gas sector, which accounts for the bulk of foreign direct investment flows, the plight of the private sector as a whole actually appears more pronounced.

The Purchasing Managers’ Index (PMI), a monthly indicator issued by Emirates NBD bank that monitors operating conditions in the non-oil private sector, shows not only fluctuations in the conditions but most recently, in September, a decline. The PMI measures conditions based on a survey of corporate purchasing managers, which assesses key indicators that are both quantitative (the volume of new orders, inventory, production, suppliers) and qualitative (the employment and labor environment).

Shuaa believes that the government opted to invest in major construction projects in the hope of stimulating employment and encouraging growth. However, the report concludes that the government should also aim to strengthen manufacturing, which is a more sustainable sector than construction and contributes to the country’s exports.

Unemployment is falling, as well as real wages

Official data from the Central Agency for Public Mobilization and Statistics (CAPMAS) shows a decline in unemployment rates from 12.8 percent in 2015 to 11.8 percent in 2017.

However, these lower unemployment rates are substantially offset by a significant decline in the purchasing power of the local currency over the same period. From 2015 until the period with the most recent available data, consumer price inflation has outpaced growth in average wages, spelling trouble for ordinary families.

Official data shows that prior to the IMF loan, the difference in growth rates between wages and inflation led to an increase in real wages. That equation has reversed in the years since the loan, as the growth rate for wages in the public budget has been in continuous decline since 2015, while consumer price inflation began to rise to record levels in 2016.

A record increase in foreign debt

According to the Central Bank of Egypt (CBE)’s monthly report, issued in the last week of October, “The balance of foreign debt amounted to about $92.6 billion at the end of June 2018, an increase of about $13.6 billion compared to the end of June 2017.”

Although the CBE stresses that these rates did not exceed safe limits in accordance with “international standards,” Shuaa believes that the rapid accumulation of foreign debt is striking.

Foreign debt rose from $46.1 billion in the first quarter of 2015/2016 to $92.6 billion in the fourth quarter of 2017/2018, according to CBE data, an increase of more than 106 percent in three years.

Foreign debt as a percentage of GDP rose from 15.1 percent in 2014 to 37 percent in June 2018 (more than a third of the GDP), according to CBE data. This increase is clearly beyond the expectations of the IMF, as outlined in the documents of its loan agreement with Egypt, which were made public in January 2017, two months after the IMF approved the loan.

The IMF projected that the ratio of foreign debt to GDP would reach 14 percent in 2016, 23.1 percent in 2016 and 27.1 percent in 2018.

In fact, the ratio hit 16.6 percent in 2016, 33.6 percent in 2016 and 37 percent in 2018.

“This rapid acceleration in external borrowing and reliance on the global credit market creates a sort of vulnerability in the monetary environment, which is currently being tightened,” the Shuaa report says, warning that “any drop in the currency rate may complicate matters by raising fears that lead to a collective exodus of capital.”

Pound flotation is a double-edged sword

The liberalization of the exchange rate and a reduction in energy subsidies are the cornerstone of the agreement Egypt signed with the IMF.

The IMF claimed that the flotation would help “improve Egypt’s external competitiveness, support exports and tourism and attract foreign investment … [which would] also allow the CBE to rebuild its international reserves.”

In a statement issued on November 11, 2016, the IMF expressed its view that “[Egypt’s existing]  energy subsidies are not well-targeted and benefit mostly the non-poor. They also skew production toward energy-intensive industries and away from labor-intensive and job-creating enterprises.”

However, the liberalization of the exchange rate effectively hindered the reduction in energy subsidies that the IMF had anticipated.

According to official figures, the relative size of fuel subsidies did decline significantly as a percentage of total expenditures. But this did not come as a result of lowered spending on subsidies, rather because of increased spending on other items, foremost of which is debt interest.

The amount of subsidies has continued to increase, despite the rising prices of petroleum products in the country. This increase is mainly due to the “difference in subsidy valuation based on the local currency after the flotation,” according to the Shuaa report.

Fuel subsidies increased from LE51 billion in 2015/2016 to LE115 billion in 2016/2017, a much higher figure than the LE62.2 billion the IMF had anticipated. This trend was repeated the following year, when subsidies rose even higher to LE121 billion versus the IMF prediction of just LE36.5 billion.

The amount of fuel subsidies expected in the current fiscal year is LE89 billion, compared to the mere LE19 billion forecast by the IMF.

Beesan Kassab 

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