Egypt’s reforming cabinet closed out its second year with, on the face of it, an impressive scorecard. Capital inflows hit record highs; inflation was brought down to single digits; rising oil prices and the part-privatization of Egypt Telecom swelled the state coffers; and the government made radical and widely praised changes to the tax system.
Now, with the key macroeconomic reforms completed, the market-oriented administration brought together under prime minister Ahmed Nazif over two years ago, faces the more controversial second-round reforms that will face opposition from powerful and ordinary Egyptians alike: privatizing Egypt’s bloated, loss-making state-owned enterprises, slashing subsidies and opening up to competition. All this at a time when unemployment remains high – around 10% officially – and political discontent in the Arab world’s most populous country is simmering. The reformers, it seems, have reached a critical moment.
None of this is lost on Egypt’s finance minister, Youssef Boutros Ghali. In an interview with Emerging Markets, he acknowledges the urgent need to raise the growth rate to pay for painful reforms ahead. His top spending priority, he says without hesitation, is poverty reduction and tripling the number of poorest households with access to social security.
Antibiotics
“My biggest concern is that the economy takes too long to respond,” he says. “I know we will expand, but it’s like administering antibiotics: you cannot predict how long the patient takes to respond.”
But he is also quick to point out the government’s recent achievements: “We’ve achieved growth of 5.9%; we’re contemplating 6% for this year,” he says. “So far we have succeeded, and there’s no reason why this cannot continue. We can improve targeting of spending and also reduce the deficit.”
He notes that corporate and income taxes have been slashed to reduce tax evasion. While revenues are down for the time being, the number of taxpayers has increased from 1.4 million to 2.6 million people. Instruments such as margin purchasing and short selling have been introduced on the stock market, as well as electronic trading.
Other key reforms include cutting customs duties, allowing the pound to float and tightening interest rates.
Analysts are striking a more cautious note. “They’re moving into a more complicated and sensitive phase,” says Reham El Desoki, economist at EFG Hermes bank. “This is where [the government] needs more creativity, an ability to convince the public, and basically more guts.”
Problems of privatization
The most sensitive issue is privatization. Boutros Ghali points out that a third of banks’ non-performing loans have been settled this year, paving the way for the privatization of Bank of Alexandria in November.
However, the programme as a whole has foundered. In 1991, Atef Sedki’s government promised to privatize all 314 state-owned enterprises within five years. Fifteen years on half these firms, representing over 40% of the country’s GDP, remain in state hands. One reason is that the people setting reform within parliament and the cabinet are also often heading these firms, and are loath to hurt their own interests. “It’s like asking the fox to re-organize the henhouse,” says one analyst very familiar with the situation.
Akrum Bastawi, an adviser to the government on international economic regulation, credits the government with rejuvenating the stock market, attracting FDI and putting economic reforms at the centre of its agenda. However, with the sole dealer of Caterpillar equipment as transport minister, and a major stakeholder in Unilever as trade and industry minister, the political will to “deconstruct certain oligopolies” is weak. “Who will take that step?” says Bastawi. “One must credit these businesses with driving growth in a difficult environment … Still, who will cut off his arm to help everyone else?”
The other reason the government cannot pursue rapid privatization is because it would risk making a hefty chunk of Egypt’s 5.6 million state employees unemployed – around 250,000, Bastawi estimates – creating a national security problem. Egypt’s state companies, with their guarantee of a job for life, are a de facto welfare scheme in a country with no unemployment benefits. According to Bastawi, the firms privatized so far are mostly in the “middle zone”: they were unprofitable in state hands but could be made profitable after stripping away debt and shedding excess workers. The remaining firms fall into two categories: monopolies in sectors like tobacco and sugar that are “cash cows” that provide revenue for the state, and uncompetitive firms that would become insolvent if they were privatized.
Boutros Ghali insists that the rising growth rate will help remedy Egypt’s labour woes. “That’s the bedrock of the entire programme,” he says.
Nevertheless, there is a limit to how far and how fast the government can go in paring down the bloated state sector. Farouk Soussa, director at Standard and Poor’s says this will temper near-term improvements in Egypt’s creditworthiness, as Egypt’s public debt of over 100% of GDP will be slow to come down.
The sell-off of the Egyptian bourse earlier this year, though mostly the correction of a bubble created by liquid Gulf investors, was also because “the market sensed that the opposition were gaining on the ministers… in the privatization area,” according to Hamdy Rashad, Chairman of Al-Rashad Asset Management. “The government over the years has failed terribly in winning the minds and hearts of the people towards privatization.”
Other risks
Other political risks loom large. Egypt continues to struggle with terrorist bombings within its borders, which hurt tourism and investment; trends towards radicalization may grow; and a smooth presidential transition from 78-year-old Hosni Mubarak to his successor (probably his son Gamal) are by no means certain.
It will take six or seven years to see the benefits of the “serious reforms” made by the government, says Bastawi. “Sometimes the poor see the reform process as ‘too little too late’. So far the government has successfully prevented the hardening of the perception, but the fallout that might otherwise ensue could overwhelm economic reform.”