In April 2011, with popular uprisings rippling across the Middle East and North Africa, the International Monetary Fund announced it was ready to lend $35 billion to so-called Arab Spring countries, including Egypt. Five years, three presidents and  an uncountable number of "will we or won't we?" rumors later, Egypt has a tentative deal with the IMF to borrow $12 billion over three years--the largest loan ever given to a MENA country, should the IMF Executive Board approve it.

While the money amounts to a much-needed infusion of hard currency, its real value is to bolster investor confidence, since such loans are conditioned on economic reforms. Nonetheless, some economists are not comfortable with doubling Egypt's foreign debt from what it was two years ago.

"This is an unprecedented increase," wrote economist Ziad Bahaa el Din in an August op-ed in Ahram Online, pointing out that the money needs to transform Egypt's long-term economic growth trend and achieve prosperity for the state to pay back the money without hurting the economy at large.

Egypt's cabinet finally confirmed in a July 26 statement that the country is in negotiations with the IMF for a three-year financing package. The loans come at an interest rate of 1 to 1.5 percent, finance minister Amr Garhy clarified in a television interview. They are to be part of a larger, $21-billion financing package that includes international bond issuances, support from the World Bank and African Development Bank and floating shares in public sector enterprises. The loan, Garhy said, will help meet Egypt's financing needs and serve as a stamp of approval from the IMF that will encourage an inflow of funds from foreign investors.

Throughout the discussions, both the IMF and the government have been careful to bill the reforms as home grown, pointing to the economic program presented to Parliament as well as the steps taken toward lifting fuel and electricity subsidies in 2014. Further subsidy cuts have since stalled, however. "What is wanted is a more aggressive reform agenda and the IMF may be the catalyst that brings this about," former Minister of Finance Ahmed Galal told Al-Ahram Weekly in early August.

The so-called Extended Fund Facility from the IMF to Egypt "supports the authorities' comprehensive economic reform program as approved by the parliament," wrote Chris Jarvis, the IMF mission chief for Egypt, in an Aug. 11 statement. The money aims to help "improve the functioning of the foreign exchange markets, bring down budget deficit and debt, and raise growth," wrote Jarvis. "It also includes strengthening the social safety net to protect the poor and vulnerable groups."

Since 2011, Egypt has massively depleted its foreign reserves--which have fallen from more than $36 billion before the revolution to around $17 billion--by propping up the currency in order to curb inflation and stave off social unrest. The IMF wants a "flexible exchange rate regime" driven by market supply and demand, said Jarvis. "Moving to a flexible exchange rate regime will strengthen competitiveness, support exports and tourism and attract foreign direct investment. This would foster growth and jobs and reduce financing needs."

The IMF has explicitly said that it will not dictate how Egypt should implement a flexible exchange rate.

"Going directly into free float is possible, but it's risky," said Reham El Desoki, a Cairo-based senior economist at Arqaam Capital, to Bloomberg in late August. Allowing the price of the pound to spike would likely cause rampant short-term inflation and public pushback against any further reforms. The IMF team asserts that if the program benchmarks are achieved on time, the inflation rate would be in the "single digits" during the three years of implementation, compared to almost 14 percent recorded at the end of July.

Speaking to Bloomberg, Hany Genena, head of research at Beltone Financial, believes the government needs to adopt a managed float by the end of the year. "By that I mean we're going to see weekly volatility in the Egyptian pound," he predicted. An EFG-Hermes note issued after the IMF announcement predicted that the official exchange rate would eventually settle at around LE 11.5 to the dollar. This is far cheaper than the current official rate of LE 8.89--where the Central Bank has kept the pound since March, when it finally capitulated to mounting pressure, allowing the pound to fall by around 15 percent--but stronger than the current black market rate of around LE 12.7 to the dollar. "This would be in line with parallel market trends and our own calculations," said EFG-Hermes head of research Mohamed Abou Basha in his comments on the note. This new rate would be come after the government receives the first tranche of the IMF loan, expected to be around $7 or $8 billion in October.

The reform program also targets reductions in government spending to bring down the budget deficit and government debt. In Egypt, the deficit has failed to drop below 10 percent of GDP since 2011, peaking at 13.5 percent in 2013 before dropping to 11.5 percent at the end of fiscal 2015/16; between 2006 and 2010, the deficit didn't exceed 8.1 percent. "The persistence of budgetary shortfalls during a long period... should set the alarm bells ringing," the IMF statement noted. "Furthermore, projected increases in the cost of government programs, as populations age and economic growth lags, give cause for further concern."

While the IMF hasn't set a benchmark for reducing the deficit, EFG-Hermes' Abou Basha notes that the government needs to target a 5.5-percent budget deficit by the end of the IMF program. The 2016/17 budget calls for cutting the deficit to 9.9 percent of GDP, slashing spending by almost LE 30 billion from the previous year. In the current fiscal year, subsidies spending was supposed to decrease 14 percent to LE 130 billion. Energy subsidies alone, which have been widely shown to mostly benefit the wealthy, accounted for almost 19 percent of national spending in fiscal 2015/16. Egypt's bloated public sector payroll is another critical yet politically sensitive area of proposed reform.  Operating under a cultural leftover from the patriarchal state envisioned in the socialist Nasser era, Egypt's 7-million strong public workforce has grown over the years into an increasingly wasteful drain on public resources, with government salaries alone sucking up nearly a third of the budget. At the end of August, lawmakers approved an amended version of the so-called civil service law, legislation that has sought to reform the public sector but has been met with protests from government workers. 

On the revenue side, the state is expected to pass long-awaited tax reforms. "This will be led by the value-added tax," as well as proposed real estate tax and mining tax," wrote Abou Basha. The Parliament-approved VAT rate for year one is 13 percent, increasing to 14 percent year two and for onward. The new tax is likely to mean higher prices, say analysts, as the VAT rate is higher than the current 10 percent sales tax, with more goods and services being taxed. Finance minister Garhy predicts that the VAT will increase inflation by 1.3 percent. However, it will also boost tax revenue by LE 20 billion a year to eventually equal 1 percent of GDP.

"The government's fiscal policy will be anchored to placing public debt on a clearly declining path toward more sustainable levels," wrote Jarvis. Government debt is projected to drop by LE 182 billion from 98 percent of GDP in fiscal 2015/16 to 88 percent of GDP in fiscal 2018/19, if IMF benchmarks are met.

Public debt levels have been steadily rising since the end of 2010, when Egypt's debt was at 73.7 percent of GDP.

The IMF expects savings from the reforms to be earmarked for two main purposes. The first is funding social support programs such as food subsidies, and targeted subsidies for social and health insurance, medicine, and vocational training among other things. The priority for the rest of the savings is investment in public infrastructure.

The key is whether the government will really go through with reforms without yielding to public pressure. "The discussion [now]... should explore how the state can change its economic approach, so it's not just a matter of taking on more foreign debt and further burdening the middle and poor classes without a genuine improvement in economic management," says Bahaa el Din.

© Business Monthly 2016