Egypt's Fiscal Cliff
Professor at the University of Waterloo’s Balsillie School of International Affairs and a CIGI senior fellow
I had the opportunity to attend the annual conference of the Economic Research Forum in Kuwait City, hosted by the Arab Fund for Economic Development in early March. The forum brings together leading economists and analysts to discuss the Middle East region. When it came time to assess Egypt’s economic and political situation, it was hard to find too many optimists in the room. To say that Egypt's economy is suffocating under the weight of a looming fiscal and political crisis is an understatement. Egypt is on the verge of a real fiscal cliff; if it goes over, the transition from authoritarianism to democracy will be fatally undermined.
The coming fiscal meltdown is linked to the Morsi government’s continuing political and security failures, which have greatly affected confidence in the Egyptian economy. According to some accounts, Egypt lost $20-$30 billion dollars of foreign exchange reserves in the first two years of its transition and now has only $13.5 billion left in its coffers. Hard currency is also in short supply as domestic and international investors' trust in the government has plummeted, leading to capital flight.
The fiscal cliff did not appear out of nowhere–wealthy Egyptians and international investors have been slowly taking their savings out of the Egyptian economy for some time. From the outset of the revolution, many feared (whether rightly or wrongly remains to be seen) that the Muslim Brotherhood would soon turn to draconian economic nationalization schemes–much like Gamal Abdel Nasser did with the economic elite in the 1950s–and consequently began transferring their wealth abroad. The result? An Egyptian stock exchange that is anemic at best.
The Muslim Brotherhood has not managed to stem the outflow of confidence and funds from Egypt’s economy because the more frustrated the people become, the more wealthy Egyptians fear the government will target them in a political witch-hunt for benefactors of Mubarak-era corruption, in order to deflect public pressure. The Egyptian government's recent announcement that it will fine members of the wealthy Sawiris family for unpaid taxes is a case in point. While these measures appeal to the Brotherhood's populist base, which demands compensation for years of crony capitalism, they also warn off international investors and further alienate Egypt's economic and financial elite.
The prices of imported goods keep fluctuating upward as the market value of the Egyptian pound declines in value. The extent of the economic uncertainty has brought the domestic economy to a standstill, as previously announced expansions of capital and investment have been stopped. Compounding the fiscal crunch is the loss of tourism income, which on average fueled a quarter of Egypt's economic earnings and served as a key means of capturing foreign exchange. The suspension of much Western financial aid only adds insult to injury. To put i simply, Egypt is nearing bankruptcy.
Unable to implement the difficult pre-loan conditions required to get cheaper credit from the IMF, Egypt's interest payments on the private market have become extremely high. High rates worsened an already large public debt problem, driven largely by the societal expectation of government subsidies. Energy subsidies account for approximately 80 per cent of the government's subsidy bills; food subsidies account for less but are still significant. Both pose a real socio-political challenge.
Low foreign exchange reserves and a lack of willing creditors means that in the next few months, Egyptians will face rolling electric blackouts, fuel shortages leading to industrial stoppages and long queues for vehicles, and worsening unemployment. Egypt is also the world’s largest importer of wheat, which it uses in large part to make bread that can be sold at subsidized prices to the growing masses of the poor. The foreign exchange crisis has already created wheat shortages in food manufacturing chains. It will take only a few more months for this to hit the street level at which point no more subsidized bread will be available on market shelves. With so many poor Egyptians (currently estimated at more than 20 million) who depend on bread as their major source of calories, Egypt will confront starvation on a scale it has never experienced.
Most economists believe Egypt is approaching a fiscal cliff and that this has the potential to create economic–not to mention geopolitical–shockwaves that will spread throughout the Middle East. So far, the Egyptian government has failed to secure a badly needed IMF agreement for $4.8 billion. But even if the recent request for the return of an IMF team is initiated, this will not be finalized for another eight weeks at which point it will likely be too late to avert a crisis. Egypt's only remaining benefactors are the oil-producing Arab countries in the Gulf and they are getting tired of bankrolling a country while getting nothing in return. Sly media comments about the financial vultures of the Gulf taking advantage of Egypt's ailing economy to buy political influence may keep them invested a while longer, but their patience is wearing thin.
On his recent trip to the region, U.S. Secretary of State John Kerry freed up $190 million in cash transfers as a sign of good faith, but made clear that the U.S. will not release the promised $1 billion (this would be specific debt “forgiveness grant”, to be used and administered by the U.S. for implementing education policies and others) until serious economic and security reforms are enacted.
The current chaos suggests reform is a distant prospect. But Egypt, a land of 86 million people in the heart of the Middle East, is simply too important to fail. Great political and regional chaos will follow if it does. The Morsi government must find ways to demonstrate its commitment to addressing Egypt's economic and political challenges if it wants the U.S. and the IMF to extend the lifeline that Egypt so badly needs.