The delay of Egypt’s long awaited IMF financing package is a serious blow to the country’s post-revolution transition and will add further uncertainty to an economy on the brink, experts have warned.
The on-going political crisis is seen as the main reason behind the government’s request to delay the loan.
Egypt’s economic prospects are far from sound after its tumultuous two year transition. The budget deficit widened to nearly LE 70 billion ($11.4 billion) in the last quarter, foreign exchange reserves dropped to $15.4 billion in November and the Egyptian pound is trading at 8 year lows versus the U.S. dollar.
Economists say the loan is crucial to staving off a balance of payments crisis and plugging the deficit which reached 11 percent in the financial year ending in June. The standby agreement, approved on a ‘staff-level’ in Cairo last month, would provide nearly $5bn in financing from the fund itself and unlock more than $14 billion in external financing from other donors such as the United States, the European Union and international financing institutions.
Experts described the delay as a “serious but not yet terminal” blow to the economy’s post-revolution transition and said it was clear the decision to postpone negotiations was driven by the deepening constitutional crisis that has gripped the country over the past few weeks.
“It is clear the government’s number one priority is resolving the crisis,” Neil Shearing of research consultancy Capital Economics said. “For the IMF’s part it is unlikely to want to lend in current circumstances.”
Shearing said that after the government’s attempt to defuse the crisis failed to mollify the opposition “it was only a matter of time before discussions with the IMF fell by the wayside.”
Over the past two years Egypt has resorted to draining its foreign currency reserves to prop up the Egyptian pound and prevent currency devaluation. As a result, the country was now running out of money and in urgent need of external financing.
“Egypt is treading a thin line,” Shearing said. “Foreign exchange reserves are now at dangerously low levels and without the backstop of an IMF deal there is a growing risk of a disorderly adjustment in the pound,” he said.
Alia Moubayed of Barclays Capital said the main reason Egypt requested a delay of the loan is “the realization that given the significant divisions across the political spectrum, rushing in an agreement without ensuring it is properly discussed may lead to failure in implementation down the line.”
Moubayed said it was wise to delay the loan given the extreme polarization and that fallout could be limited “if significant efforts are exerted by the government to bring other political parties on board.”
The fund has stipulated broad-based domestic support for Egypt’s economic program as a pre-requisite to financing.
Moubayed acknowledged it would be a challenge to convince political opponents of the urgency of needed reforms but said consensus was necessary.
However, should the delay reveal a lack of commitment to reforms or inability to implement them, then “a negative scenario may unravel very quickly,” she said.
After nearly three weeks of political unrest over the country’s constitution and president Mursi’s controversial decree, the Finance Minister Mumtaz Al-Saeed said on Tuesday that the government had agreed with the IMF to delay a $4.8 billion loan for a month to allow for dialogue on the government’s economic program.
"Of course the delay will have some economic impact but we are discussing necessary measures (to address that) during the coming period," Al-Saeed told Reuters. "I am optimistic.. everything will be well, God willing," he said by telephone.
The announcement came one day after a dramatic u-turn by President Mursi over a proposed tax hike and followed an earlier statement from the prime minister, Hisham Kandil, refuting ‘erroneous’ reports on the tax rise and calling for “social dialogue” on tax reforms and the government’s economic plan.
The IMF’s board was set to ratify the agreement at a meeting in Washington on Dec. 19. The fund issued a statement saying that “in light of the unfolding developments on the ground, the Egyptian authorities have asked to postpone their request for a stand-by arrangement with the IMF.”
The statement went on to say that the IMF would remain in close contact with the authorities and would consult with them on the resumption of discussions for the loan.
Over the past few weeks, economists have warned about a possible delay in IMF approval following the unrest triggered by the president’s controversial decree.
Wael Ziada, head of research at investment bank EFG-Hermes, said the delay was a reflection of the current political instability and would have a negative effect on the investment climate and stock market. He said political developments would be the main determinant of what happens next.
“Right now you have a political environment that is not conducive to making the right economic decisions,” Ziada said.
He pointed to the government’s attempt to kick off its economic plan with a tax increase only for the decision to be swiftly retracted by the president hours later.
“It is very difficult with the political congestion and the significant polarization to pass taxes or economic measures of that nature,” he said. The success of tough economic policies depended in large part on the timing of their implementation, he added.
Successful implementation of the government’s economic plan is a key requirement to secure IMF financing and the latest u-turn highlights the difficulty of winning support for unpopular economic reforms, particularly at a time of deep division.
Angus Blair of the Cairo-based think tank Signet Institute said the decision to ask the IMF to delay the loan was ‘a reflection of politics rather than finance.’ He said he believed there was a considerable amount of goodwill in Washington and in Europe to help Egypt through its transition.
In the wake of the latest crisis, the IMF said “consideration of the agreement by the IMF Executive Board will require that there is no major change in the economic outlook and implementation plans.”
The IMF also said it would require assurances from other donors - such as the United States and the European Union - that their share of financing will also be forthcoming. Some members of the European parliament have called for a suspension of economic aid to Egypt following the president’s decree.
Egypt’s economic plan, which has been presented to the IMF, centres around deficit reduction and features two key components: cutting government spending by reducing subsidies on fuel and electricity and increasing revenue through raising taxes on income, capital gains, goods and services.
Egypt’s trajectory towards IMF approval also hinges on implementing key “prior actions:” removal of subsidies on high class 95 octane fuel, which came into effect last month; expansion of the tax base through progressive income taxes, approved in November; and adoption of a more flexible exchange rate for the currency, which, according to the text of the government’s economic plan, the central bank is pursuing, albeit with the added proviso of “avoiding sharp fluctuations in exchange rates.”
Shearing of Capital Economics said it was extremely difficult to forecast how the situation might develop but that if the political environment stabilized, the risk of economic crisis would ease and external assistance would be likely, particularly given Egypt’s key role in the region.
“I can’t see the IMF, the U.S., or Saudi Arabia letting Egypt go through a really messy painful economic crisis at this juncture, I think they will cobble something together,” he said.