beyondbrics

By Theodore May of Ergo

The Egyptian government appears to be seriously reconsidering a loan from the International Monetary Fund that it turned down last June. Early this month, Egyptian officials invited a delegation from the IMF to Cairo to discuss the country’s finances and to revisit the possibility of a loan.

The conversation is timely. The country faces a worsening budgetary and liquidity crisis, and the loan offers a major opportunity for Egypt to dig itself out from its current situation.

The two-and-a-half week uprising that toppled the regime of President Hosni Mubarak significantly curbed forecasts for Egypt’s economic growth, plunging the country into an economic crisis. In fiscal year 2009-2010 (the last before the onset of the Arab Spring), GDP growth stood at 5.1 per cent. Due to the ensuing civil unrest, however, GDP grew just 1.8 per cent in the fiscal year that ended on June 30, and economists are predicting little better for the current fiscal year.

While foreign direct investment (FDI) in Egypt had been a success story before the revolution, investors have shunned the country since political instability took hold this January. FDI grew from under $1bn in 2004 to over $11bn in 2007. This year, though, FDI is not expected to top $3bn. Egypt’s foreign exchange reserves are also collapsing. International reserves were $22.1bn in October, marking 10 straight months of decline. As reported in the Financial Times, analysts warn that Egypt’s foreign reserves risk running dry by next year without foreign intervention.

Even as revenue plummets along with foreign investment and currency reserves, Egypt’s ruling military council has signed off on a budget increase of 14.7 per cent for the current fiscal year in order to bolster social programs and head off unrest during these politically trying times. The military dedicated the bulk of the spending increase to education and healthcare. It also increased spending on subsidies, which — especially for food and energy — account for a staggering one-third of government spending. Subsidies are a critical lifeline for the poor, and popular unrest has made reforming them a third rail in Egyptian politics.

In light of these economic challenges, the IMF offered the Egyptian government a $3bn 12-month standby loan in June. While the government was prepared to accept the loan, Egyptian activists across the political spectrum demanded that the government reject it, expressing mistrust for the fund over its long support of the Mubarak regime. They also argued against the stringent conditions that typically accompany IMF loans, including specific spending cuts, interest rate targets, and requirements for how the loan money must be spent. The government acceded to the activists’ demands, turning down the loan as part of a vain effort to restore stability.

Instead, Egypt has looked to non-Western sources for aid. Reports indicate that the Egyptian government has accepted a $1.4bn loan from the African Development Bank, and Qatar gave Egypt a $500m grant last month. These aid packages have been helpful, but the situation in Egypt is dire enough that it must explore every available avenue for financing. Only when coupled with a substantial loan from the IMF will other sources of aid begin to make a dent in Egypt’s growing budget deficit, meaningfully boost foreign reserves, and encourage economic growth.

The IMF loan offers a major opportunity for Egypt to dig out from its current crisis. Accepting the $3bn loan would serve several critical functions. It would play a role in insuring the government’s solvency and reducing an estimated $23.7bn budget shortfall the country faces for the fiscal year ending June 30, 2012. Moreover, accepting Western aid would restore confidence in Egypt among foreign investors — not only by improving the country’s foreign reserve position, but by demonstrating that the government is committed to putting economic health ahead of political interests.

If Egypt does not choose to accept the IMF loan and allows its current economic problems to fester, the consequences could be severe. A stagnant economy will increase unemployment and antagonise a labour force that remains unsettled after overthrowing the Mubarak regime. Every year, roughly 500,000 Egyptians enter the job market, and nearly two-thirds of the population is under 30. According to IMF data, in 2010 the unemployment rate was 9 per cent, and is set to reach 10.4 per cent in 2011.

In order for job creation simply to keep up with new entrants into the job market, the economy will have to grow more than 5 per cent a year. Accepting the IMF loan will give the Egyptian economy a sorely needed path back to the economic growth levels it so desperately needs.

Without bold policy implementation to correct the country’s economic course and begin creating jobs at a meaningful rate, Egypt will face long-term unrest and instability. The IMF’s visit to Cairo, as well as an announcement from Egyptian Finance Minister Hazem El-Beblawi that the government would reconsider the loan, indicates that Egyptian officials are ready to focus on remedying the deteriorating economic situation. A loan from the IMF will not solve Egypt’s problems, but it would mark a positive step.

Ergo, a global intelligence and advisory firm, is producing a series profiling the leading figures in politics, government, and business in Egypt and several other countries in the region.

Related reading:
Egypt: the mounting cost of protest, beyondbrics
Turmoil hits Egypt’s foreign currency reserves, FT