Like an ambivalent marriage, The International Monetary Fund’s on-off relationship with Egypt (which dates back to the 1980s) is back on track.
There is $12 billion on the cards for Egypt, subject to final approval from the IMF’s executive committee. A green-light on the three-year loan package is expected to be followed by a flood of cash from the Gulf, the World Bank and African Development Bank.
Yet for the billions of dollars Egypt has received in the last five years – over $25 billion alone from Gulf States – there is one issue that has the country tied down in a vicious cycle: the banking system, nearly half government-owned, is inextricably indebted to the Egypt’s finances, allowing it to rollover maturing local currency government debt, which is a whopping 30% of GDP, while also providing new financing. Banks are also obligated to invest enormous amounts in Treasury Bills, the hard currency short term debt that the country taps into regularly.
But much of this money has gone to financing deficits and propping up a hugely overvalued currency.
What does this mean for the economy? The government is allowing its banks to superficially support its finances, allowing it to inch along, plug gaps as they appear, without acknowledging deep rooted social and economic reform that is mostly grounded in infrastructural changes. It’s reached a point that the government’s dependance on banks is the “only reason why a full blown economic crisis has not taken place, despite extremely weak economic indicators,” according to Raza Agha, the chief economist of MENA at VTB Capital:
I do not think lending these amounts is healthy – it crowds out generally more productive private sector needs. Plus, lending such amounts also creates enormous risks for banks balance sheets/financial sector in general.
So what does this kind of support look like on paper? First of all, look at what happens when credit to government overtakes the private sector (note: this happened right around the beginning of the Arab Spring, when the red line overtook the blue line):
The chart shows that net credit to the government and public sector businesses is over 1000% of bank capital and reserves, a huge burden to place on the banking sector. Then look what happens when banks go crazy on Treasury Bills, again to support the government:
Banks’ investment in Treasury Bills is 1200% of their capital base. Twelve hundred percent. Agha explains why banks do this:
There are regulatory reasons; there could also be “encouragement” by the government to invest in upcoming auctions of government bills (it’s easy to be convinced when the public sector ownership dominates the banking system); there may also be risk-reward considerations – if banks can earn double digit returns by lending to the government, which technically cannot default in local currency, why engage in riskier private sector lending at a time when growth dynamics are weak?
The banking sector has little choice. Why invest in a potentially more lucrative private sector when the safety and reward is with government lending, and they’re telling you there’s no risk of default?
But it’s a risky game. For instance, this system is predicated on the fact the country’s credit worthiness (which gives investors a window into the level of risk associated with investing in Egypt including political risks) remains fairly steady. If it was to sharply drop, then the banks would be lumped with very risky debt. Agha puts it into context again:
[Egypt’s] credit worthiness is already amongst the weakest I have seen across single B rated countries [see here for definitions of credit ratings]– this is clear in their debt levels, debt servicing pressures and the extent of external financing needs.
In a country ruled by the government of Abdel-Fattah el-Sisi, a former army general who seized power from an elected Islamist government three years ago, there are of course other doubts over the success of the IMF loan. Will it tend to rising inflation and the 13% jobless rate? Will it narrow the huge budget and current-account deficits—almost 12% and 7% of GDP, respectively? As Bloomberg’s editorial board puts it in this great op-ed:
IMF officials practically admitted that the new package is mostly cosmetic. The fund and Sisi’s friends in the Gulf need to insist on real reform. Egypt should invest in simple infrastructure such as roads, schools and water-supply systems; make it easier for small and medium-sized business to get bank loans; and break up the military-industrial monopolies in everything from washing machines to olive oil.
The IMF loan is only a window to recovery. Egypt must find a way to balance the social cost of reform with the economic cost of no reform. So far, Sisi seems to have focused much of his economic reform rhetoric on a $45 billion mega-city, which was quietly shelved.
General Abdel Fattah el-Sisi must be revelling in the image of an all-powerful oligarch created by the media.
Apparently he reigns over a sprawling economic empire that journalists describe (in now rather cliched terms) as so varied that it covers everything from the production of flat-screen televisions and pasta to refrigerators and cards.
It’s claimed that the army has control over as much as 40% of the Egyptian economy. It owns football grounds and restaurants and provides services such as managing petrol stations.
Some even estimate the military control as much as 80% of manufacturing alone. But then again, that estimate came from FOX News, not the most reliable of sources.
The truth is, the Egyptian military is far from being a well-oiled business machine. In fact, historically, the army have been very bad at making money and its own failures have led it to seek other forms of income. Why else would an army diversify its interests so considerably?
The pitfalls of the military’s weak economic strategy are laid bare in this detailed paper by Stephen H. Gotowicki, a lieutenant colonel in the U.S. Army who worked in the Army’s Foreign Military Studies Office:
In the coming years, Egypt’s military production sector will probably decline. Egypt suffers from low productivity, a lack of adequate funding and a dearth of external markets. Egypt’s largest customer during the 1980s, Iraq, has been removed from the market place as a result of UN sanctions imposed against Iraq for its invasion of Kuwait. Egyptian military products also face increased competition. The cash-strapped Russians are offering highly advanced weapons at bargain prices.
Egypt’s military industries have not promoted import substitution or sustained export earnings. The technological benefit of the armed forces’ military industrial endeavors have proven to be only marginal to Egypt’s economic developments. While Egypt does assemble sophisticated military weapons systems, the facilities to do so are provided by Western businesses on a “turn key” basis.
The Egyptians receive kits for assembly, but the technology involved is closely maintained by the Western partner. Hence, little technology that would allow independent Egyptian development of systems has been received. For Egypt, technology is a conundrum — high technology industrial efforts are a capital intensive endeavor; Egypt has a labor intensive economy with little capital. Finally, it would appear that Egypt’s military industries have done little to enhance its regional power.
In other words, Egypt’s army failed miserably at the one thing they should have been doing well – military production.
The piece goes onto explain how “self-sufficiency would permit a greater measure of Egyptian independence in security matters and should allow the Egyptian military to fight longer without foreign resupply.” Now the refrigerator production and petrol station management makes sense. The army, if anything, is simply trying to keep its head above water.
Contrary to popular belief, General Sisi and his partners do not have a powerful grip on the economy, nor are they savvy businessmen out to expand a flourishing empire. They are interested mostly in protecting the economic interests that allow them to be self-sufficient and not reliant on foreign partners.
It’s a lazy approach to their business and part of the reason why we have seen the army interfere in the transition so much – to manoeuvre Egypt, as much as possible, out of economic decline and shield its factories and production lines.
But still, the military plays no significant role in any of the major Egyptian industries today – oil and gas, steel and cement. The businesses that the military does play a role in would certainly not give them control of over 40% of the economy.
That figure has never really been verified or proven, with only a few rare instances when the military did reveal how much money they make.
At one point just before the January 25th revolution, Businessweek ran an interview with the then minister of military production, Sayed Meshaal, saying the army made about $345 million in revenue from the private sector, a far cry from the billions of dollars they are claimed to generate.
What’s more, the army’s “economic strategy” is riddled with corrupt practices. Mr Meshaal, who served as the minister of military production till 2011, is now being investigated for awarding contracts “above cost”.
In another example of dodgy money management, millions of dollars of profits from military industry exports during the 1980s and 1990s were reportedly returned to the military coffers with no government accounting or taxes (i.e. “off-budget”).
The military are far from being shrewd businessmen. Instead, because of a track record of losing contracts, bad ties to regional powers and dodgy accountancy, the army are relying on selling bottled water and other domestic goods to survive.
Plus, the military’s role in the economy actually stifles free market reform by increasing direct government involvement in the markets.
General Sisi has said nothing about the army’s economic prerogative but we can already deduce what the military is interested in: remaining conservative, keeping policy simple without innovation or anything too radical (such as cutting those precious energy subsidies that the army rely on so much to run their factories at a cut price) and focusing on big, state-run projects (just like Mubarak).
With no real systemic changes being offered, the army has missed an opportunity to save the economy and much to their demise, protect their own economic interests.