Egypt and the IMF

by robert looney
 
Associated Press

robert looney teaches economics at the Naval Postgraduate School in California.

Updated November 14, 2016.


The opinions expressed are solely those of the authors and do not necessarily represent the views of the Institute.

Last week, the IMF agreed to provide Egypt with the second largest ($12 billion) bailout in the international lender’s history. It is almost triple the size of the package offered to the post-Mubarek democracy during the short-lived presidency of Mohamed Morsi.

Generous the IMF may be, but the conditions it set for the loan suggest the giant multilateral lender is insisting on getting some bang for its bucks. To begin, the government must find another $6 billion in loans from other sources at a time when its rich benefactors on the Persian Gulf are pinching pennies. And it must make a major push to put the country’s finances on a sustainable basis.

The latter includes instituting a value-added tax or something like it to generate a lot of revenue, and allowing the Egyptian currency’s exchange rate to track supply and demand in order to make exports more competitive. It will also involve a significant reduction in the scattershot food and energy subsidies that crowd out funds for every other item in the budget (save for the care and feeding of the military).

However, whether the IMF program for Egypt is good news or bad depends on one’s point of view. According to advocates including Mohamed El-Erian, the Egyptian-American financier who chairs President Obama’s Global Development Council, the giant loan will bring desperately needed foreign exchange and, with it, the flexibility to restore macroeconomic stability. Skeptics, on the other hand, note that the IMF is the international lender of last resort, with austerity programs whose success has been mixed at best. Furthermore, even successful IMF programs often come at considerable short-term pain in the form of layoffs and a rising cost of living — hardly a low-risk proposition in a seethingly angry country already living with widespread poverty and double-digit unemployment.

Unfortunately, the state of Egypt’s economy, which has been battered by revolution and counterrevolution since the Arab Spring, leaves the government with few other options. As the IMF reports, Egypt’s economic growth, which ran at an acceptable 5 percent per year from 2000 to 2010, has fallen by half, while the pace of investment has fallen by one-third. Foreign exchange reserves, which were around $35 billion in January 2011, dropped to less than half that figure by mid-2016, despite at least $20 billion in aid from Saudi Arabia and other Gulf states since 2011. Moreover, falling oil prices, not to mention the cost of Saudi Arabia’s involvement in both Yemen and Syria, will likely make future assistance problematic.

Some of Egypt’s economic woes can be traced to forces beyond Egypt’s control. For example, since the destruction by terrorists of a Russian airliner over the Sinai Peninsula in October 2015, tourism has fallen by more than half, with no recovery in sight. Meanwhile, remittances fell by 6 percent in 2015, in part reflecting tougher economic conditions for Egyptians working in the Gulf states, while Suez Canal fee income is suffering from the slowdown in global trade.

However, most of the Egyptian government’s economic problems are self-inflicted, as summarized by significant erosion in Egypt’s performance in the World Bank’s governance indicators. Egypt’s place on the political stability/absence of violence index, which averaged in the 27th percentile among countries surveyed in the decade leading up to the Arab Spring, has since fallen to the 7th percentile, while rule of law rating declined from the 53rd to the 37th percentile.

 
Corruption is so severe that the government’s top auditor publicly estimated it drained the country of $67 billion between 2011 and 2015.
 

Corruption is so severe that the government’s top auditor publicly estimated it drained the country of $67 billion between 2011 and 2015. (The auditor has since been prosecuted for whistle-blowing.) And with institutions of governance in disarray, it should not be surprising that Egypt fell from the world’s 70th most competitive economy in 2009 by the World Economic Forum’s reckoning, to a miserable 116th in 2016 — behind the likes of Lesotho and Ethiopia.

The desperation of the situation is brought home by Egypt’s willingness to turn to the IMF for a bailout. A 1970s IMF austerity program in Egypt resulted in riots over the withdrawal of bread subsidies which almost toppled the government. As a result, successive governments have shied away from IMF assistance, fearing that mandated austerity and tax increases would stoke popular unrest long before any benefits in terms of lower inflation or increased investment and jobs were visible.

Managing a program of the scope of the proposed IMF plan, moreover, will severely test the administrative capabilities of the government. While efforts will no doubt be made to minimize the impact of higher food and fuel prices on the poor by providing more narrowly targeted compensation, Egypt’s record of corruption and sheer bureaucratic incompetence suggest that a lot of people living at the margins will still suffer mightily. A quarter of all Egyptians (disproportionately living in rural areas) live below the poverty line. And a quarter of all young adults are unemployed. Whether, under the circumstances, the military can tamp down violent protests is anyone’s guess.

One way to minimize suffering (and the prospects for instability) would be to stimulate growth during the early phases of the austerity program. Yet it is unclear at this point where the growth and employment opportunities could originate.

The Fund’s attitude is that, once macroeconomic stability is established, there will be a surge in job-creating foreign direct investment. However, if the program is simultaneously creating social instability, foreign investors are likely to stay away. In any case, foreign investment is usually capital intensive and hardly a panacea on the job front in a country that lacks the sort of disciplined labor force taken for granted in southeast Asia. Indeed, the relatively buoyant years that preceded the global recession in 2009 were a period of growing income inequality, in which Egypt’s unskilled got the short end of the stick.

Another difficulty with the IMF loan program will be debt servicing, particularly if the tourism industry fails to rebound and oil prices do not recover sufficiently to drive up remittances from Egyptians working abroad. Egypt’s economic planners have long preferred to put their hopes on grandiose development projects, such as the costly, ill-considered expansion of the Suez Canal and a proposed new administrative capital outside Cairo. And the current government, which depends on the military’s loyalty for its survival, is plowing cash into military-owned civilian businesses that are almost guaranteed to be a drag on productivity. As a result, the government lacks both the will and the long-term planning capability to direct scarce tax dollars into projects with a high social return.

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The pity here is that Egypt was far from a basket case in the last decade of the pre-Arab-Spring regime. The economy certainly faced huge obstacles to sustainable growth, ranging from corruption to monopoly-friendly regulation to poor education to a parasitic military. But growing it still was — and there was hope that it could manage the sort of two-steps-forward, one-step-back reforms that would eventually allow a successful market-based economy to emerge.

Now, those obstacles seem more like mountains. The nation is bitterly divided between the largely rural followers of the Islamic Brotherhood and the largely urban secular middle class, united only by their loathing of the self-appointed government. And it is hard to imagine the circumstances in which an IMF bailout could lead to the self-sustaining changes needed for Egypt to fulfill its economic potential. 

main topic: Middle East
related topics: Capital Markets, Economic Development