With domestic financing no longer available at an acceptable cost to the economy, the resort to the increasingly-hard-to-get external support has quickly become the only option.
Regardless of who is elected, one of the toughest challenges the new president of Egypt will face is to secure the hefty US$22.5 billion needed to finance the deficit of the recently released state budget for the fiscal year (FY) 2012-2013. Given the sorry state of the post-Mubarak economy and the deep financial woes of the past 16 months—compounded by the political unrest and uncertainty likely to persist even after the inauguration—this will be a daunting task.
The Egyptian banking sector has been weakened by extensive government borrowing: 50 percent of banks’ total deposits are presently in treasury bills and state bonds, and 75 percent of all new deposits go to finance the state’s recurrent expenditures—leaving little overall to the private sector
On June 4, the government finally submitted its new FY 2012-2013 budget to the parliament for ratification—two months past the April 1 deadline. The interim cabinet had endorsed the budget on May 17 and presented it to the ruling Supreme Council of the Armed Forces (SCAF) for approval. As in the recent past, most expenditures (78 percent of the new budget) will finance three major items: salaries for an estimated 6 million state employees, subsidies for energy and basic foodstuffs, and service payments for domestic and foreign debt—which is fast approaching the size of Egypt’s economy. This time, however, finding the resources to bridge the financing gap of the new budget will prove much more challenging.
Post-revolution fiscal troubles started with the present FY 2011-2012 budget—the first one put together after Mubarak was overthrown. Its estimated funding gap was $23 billion—about 10 percent of Egypt’s gross domestic product (GDP)—and was mostly financed through two main sources: domestic borrowing and Egypt’s foreign exchange reserves.
Neither of these is likely to be available to finance next year’s deficit. Official foreign reserves have been depleting at an average rate of $1.4 billion a month and are now down to less than 40 percent of their January 2011 level. At $15.2 billion, this is barely enough to cover three months’ worth of imports. Likewise, the Egyptian banking sector has been weakened by extensive government borrowing: 50 percent of banks’ total deposits are presently in treasury bills and state bonds, and 75 percent of all new deposits go to finance the state’s recurrent expenditures—leaving little overall to the private sector. This has resulted in a record 16 percent interest rate—not to mention the high (and rising) exposure of the financial industry to sovereign debt.
Worse still, the Central Bank of Egypt has lowered the required reserve ratio twice this year—on March 20 from 14 to 12 percent, then once more on May 28 to 10 percent—to provide local banks with excess liquidity to buy treasury bills. Yet this will further increase banks’ exposure to state debt. Desperate for cash, the government issued “diaspora bonds” last March in an attempt to tap into the savings of the Egyptian expats in the Arab Gulf region. Though no official figures have been released, proceeds from the sales so far seem to fall very short of the $2 billion the government had projected.
The money has to come from somewhere if Egypt is to avoid an economic calamity that could be triggered by a sharp fall of the Egyptian pound—which many analysts have been predicting for more than six months
Two external factors could add to the fiscal predicament in the next year. Sluggish growth in Europe (projected at near zero in 2012) could pinch Egypt’s prime export market (36 percent in 2010) and the source of much of its foreign investment (61 percent in 2010). Additionally, Egypt remains very vulnerable to world prices of food and fuel—it imports 60 percent and 40 percent of both commodities respectively. Spikes in prices could further complicate its fiscal management.
With current sources of finance becoming either unattainable or insufficient—and barring banknote printing or politically-risky budget cuts—one option remains to finance the next year’s deficit: foreign borrowing. Egypt’s current external debt, at $33.7 billion, is relatively low to its overall debt and GDP, constituting 15 percent and 13 percent respectively.
But accruing foreign debt may prove problematic for a variety of reasons. For one, the country’s global credit rating has slid as a result of continued political unrest, growing fiscal deficit, and declining foreign reserves. Over the span of just four months (October 2011 to February 2012), Standard & Poor’s downgraded Egypt’s long-term foreign-currency sovereign credit rating three separate times: from BB to BB-, later to B+, and then to B. This makes borrowing from international financial markets much more costly, as demonstrated earlier this year when negotiations broke down between the Egyptian General Petroleum Company and Morgan Stanley over a billion-dollar loan because of the restrictive terms.
Borrowing from international organizations may not come easy either. For the past six months, Egypt has negotiated with the International Monetary Fund (IMF) for a $3.2 billion loan without being able to close the deal. Lack of internal political consensus over the loan (a condition set by the IMF) is said to be delaying the final approval. The inability to arrive at a national agreement seems to be a result of party politics rather than of divergent views on the nature of the constraints facing the country’s public finances. Apparently, the Islamist Freedom and Justice Party (FJP) did not want an interim government to negotiate a loan deal.
Even the $20 billion promised a year ago by the G-8 nations in the “Deauville Partnership”— reaffirmed last month at the G-8 Camp David Summit—to assist reform in the countries of the Arab Awakening (mainly Egypt and Tunisia) seems to be out of reach. This financial assistance was intended to support these nations’ efforts to (among other things) improve governance, increase economic and social inclusion, and modernize their economies. In the midst of Egypt’s bumpy transitional period, little was done to reform these areas and, as a result, money for support has not been forthcoming. Given the stunning outcome of the first round of presidential elections and the largely problematic choice of candidates presented to voters in the runoff, it is highly doubtful that post-election Egypt will, at least in the short term, be any different.
Egypt remains very vulnerable to world prices of food and fuel—it imports 60 percent and 40 percent of both commodities respectively. Spikes in prices could further complicate its fiscal management
But the money has to come from somewhere if Egypt is to avoid an economic calamity that could be triggered by a sharp fall of the Egyptian pound—which many analysts have been predicting for more than six months. With domestic financing no longer available at an acceptable cost to the economy, the resort to the increasingly-hard-to-get external support has quickly become the only option.
Whoever the new president of Egypt will be, he has a tough sale to make. Two audiences are critical to his success in defusing the ticking fiscal time bomb. He must convince a newly empowered constituency of the urgent need for outside aid, including debt—something they have resented of late. Second, he must show Egypt’s prospective donors and lenders (both in the region and outside it) a workable plan to stabilize the country in two crucial areas: internal security and economic reforms. Given the political complexities surrounding the runoff to come, this “sale” could very well be close to impossible.
So forget the promises made during the presidential election campaign season; they all pale in comparison to the enormous and much more immediate fiscal challenges the new president will face when he takes his office on July 1—not just inauguration day, but the beginning of the new fiscal year.
Mohammed Samhouri is a senior economist at the Cairo-based Regional Center for Strategic Studies, and a former senior fellow and lecturer at Brandeis University’s Crown Center for Middle East Studies in Boston.