Last Updated: Thu Mar 01, 2012 12:06 pm (KSA) 09:06 am (GMT)

Egypt interim government faces tough task selling IMF reforms

Finance Minister Mumtaz al-Saeed was quoted as saying it includes changing Egypt’s 10 percent sales tax to a value-added tax (VAT) and directing energy subsidies to those who most need it. (File photo)
Finance Minister Mumtaz al-Saeed was quoted as saying it includes changing Egypt’s 10 percent sales tax to a value-added tax (VAT) and directing energy subsidies to those who most need it. (File photo)

Egypt’s interim government will have to muster all its skills of persuasion to sell austerity measures to a country weary after a year of political and economic strife, if details emerging on Cairo's planned deal with the IMF are anything to go by.

Egypt wants the $3.2 billion IMF accord to help it head off a looming crisis. But in return the IMF wants Egypt to cut its budget deficit.

“The IMF agreement has conditions that Egypt is expected to fulfill for the money to come,” said an Egyptian official who has been closely following the talks. “One of them is reducing the country's budget deficit.”

The official, who asked not to be named because he is not authorized to speak to the media, added that “those conditions have political consequences” and this is why officials have said in the past that IMF conditions affect Egypt’s sovereignty.

The IMF has asked Egypt to draw up an economic reform plan with benchmarks and targets, sell the plan to the country's political forces, and line up aid pledges from other donors.

The unelected administration will be proposing the related measures as it steers the country through the contentious process of drafting a new constitution and holding a presidential election by the end of June.

The government announced this month it had approved a plan that would run for the length of the 18-month IMF program and would sign an accord in March. But so far it has not released the plan for public debate as promised, and the IMF has said tersely that talks are still underway.

Few details have been released on the plan’s austerity measures, but on Feb. 10 Finance Minister Mumtaz al-Saeed was quoted as saying it includes changing Egypt’s 10 percent sales tax to a value-added tax (VAT) and directing energy subsidies to those who most need it.

New taxes and fewer subsidies are never popular, and the government has long tried unsuccessfully to enact similar measures. The sales tax was introduced as part of an earlier IMF program in 1991 as the first step toward a VAT, and Youssef Boutros-Ghali, finance minister under Mubarak, had argued for a switchover to VAT throughout his seven years in office.

The now-reviled Boutros-Ghali also tried to tackle energy subsidies, which are eating up an ever-increasing share of the state budget as consumption grows.

As recently as late 2010 he sought a rationing system for subsidized liquid petroleum gas (LPG) sold in canisters for household cooking. Energy subsidies, especially for diesel, LPG and fuel for industry, make up almost 20 percent of the budget.

Time bomb?

The Egyptian uprising was driven in part by economic grievances, and a year later strikes by workers demanding higher pay and better contracts continue to break out daily.

“How will you reduce subsidies when people are complaining about inflation, unemployment and inequality? It will be a hot potato in terms of the politics,” said Raza Agha, an economist at the Royal Bank of Scotland.

The IMF has demanded that any accord have broad political support within Egypt, especially from the Muslim Brotherhood, which won nearly half the seats in the new parliament. The Brotherhood so far has rejected an accord except as a last resort, but analysts say it may have no choice but to go along.

A big question is whether Egypt has the resources to get through the presidential vote before a financial crisis hits.

The country has been spending $2 billion a month of its foreign reserves since October to prop up its currency. Reserves, less than half of what they were before the uprising, now stand at a worryingly low $16 billion, including $4 billion in gold bullion the government would be loath to draw down.

“If they carry on at the current rate, their reserves would nearly all be exhausted by then,” said Said Hirsh of Capital Economics. “Then they would be at tipping point, which means you could get a totally disorderly devaluation.”

This would boost inflation, prompt the government to raise interest rates to support the currency, reduce asset values and push borrowing costs up in an already weak economy, he added.

Even if it gets internal backing for the plan, the IMF has said Egypt must line up funds from foreign lenders to plug a funding gap the government estimates at $11 billion over the 18-month program, meaning it would still have find about $8 billion from donors other than the IMF.

Egypt has asked the World Bank for $1 billion, the European Union for $660 million and $500 million each from the African Development Bank and the Arab Monetary Fund.

The country seems to be counting on help from Gulf States for the rest, but the finance minister was quoted last week as saying the fate of that aid was unclear. Saudi Arabia had pledged last year to provide up to $3 billion in budget support.

Prime Minister Kamal al-Ganzouri has said Gulf countries wanted an IMF agreement before they lend money to Egypt. Analysts say they also may not be comfortable sending funds until they see what kind of government emerges in July.

As a backup, Egypt is studying other ways to fund its budget shortfall, including selling certificates of deposits and land to Egyptians living abroad and issuing Islamic sukuk bonds.

The danger is that many of these are one-off measures that don't reduce the budget deficit in the long term, analysts say.

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