Category Archives: United Arab Emirates

“Energy subsidies” has become a phrase synonymous with the Middle East’s feeble efforts to reform and rightside budgets. 

Governments across the region, including Egypt, Jordan, Morocco, and to some extent even oil-rich Gulf states like Saudi Arabia, have struggled to address their addiction to subsidies that provide cheap fuel to sate the masses. They want to scrap expensive energy subsidies but fear they will provoke riots if they do.

But as huge international institutions like the International Monetary Fund and the International Energy Agency muscle in with their expertise on how to end this costly system that will cost $600 billion this year, a substantial error has been overlooked.

These multinational organisations claim they have the technical expertise to help the Arab world with its most costly problem, but in fact have no standard way to measure energy subsidies, according to energy consultancy OpenOil.

Stephanie Heerwig, writing for OpenOil, explains:

The IMF, IEA, EIA, OECD, UNEP, you name it – use either different methodologies or different assumptions or both and routinely come up with wildly different estimates for the same country in the same year.

Not only are the data swilling around the public domain confusing – I might expect that – but the methodologies and assumptions on which it is based are incoherent most of the time. And what is particularly striking – there is no consensus on how to measure the subsidies. How could that be, given their huge impact on carbon emissions and government budgets?

So while the definition of energy subsidies is easy, there are hundreds of mechanisms that could fall under “an energy subsidy”.

What I have found out, especially when reading a brilliant paper by Doug Koplow, is that not only do major organizations often use different methodologies, they may use different underlying assumptions to arrive at radically different results even with the same methodology.

For instance, according to estimates by the International Energy Agency the total amount of subsidies on oil products in Egypt amounted to $9.2 billion in 2007. The IMF, however, estimates a figure of $3.8 billion, for the same year using the same methodology! That is a difference of about 58 percent! What a statistical margin of error. 

Koplow, in the paper, compares 2007 estimates for total amount of subsidies on oil products from two of the biggest organisations, the IEA and the IMF (in billions of US dollars):

Heerwig goes into some detail on how these organisations come to such conflicting data. The conclusion is clear, however: If “experts” can’t even agree on the level of subsidies in each country, how can we expect the Egyptian government which is going through a monumental transition, to come up with a better alternative?

No, this doesn’t mean Egypt is off the hook. But the nation, and others in the same boat, must seek as many different opinions as possible to come to a sound solution. This argument inevitably ends at the same conclusion for Egypt: be more inclusive and do not continue to mistake that working in isolation is a mark of power.

“It is paramount, essential, urgent that the Egyptian economy get stronger, that it gets back on its feet,” the US secretary of state John Kerry told Egyptian businessmen this weekend.

The message was clear and has been reiterated many times before: instil the economic reforms needed to satisfy the conditions the International Monetary Fund has set for a $4.8 billion loan. But Egypt is stuck between a rock and a hard place. 

Many international lenders say they will not step forward with help until the nation is politically stable. But the country is unlikely to gain stability without a widely accepted plan to create jobs and inclusive growth.

And is it really fair to ask for political stability when a country as big and polarized as Egypt is testing democracy for the first time in decades? The problem lies with the attachment of the IMF loan to any international loans and aid.

For foreign officials, including Secretary Kerry, to continue characterising the IMF loan as the fix-all solution for Egypt’s economic problems is wrong.

The IMF loan is a red herring that, once signed, will release macro-loans to Egypt from Europe, the World Bank and the African Development Bank. This money will be focused on monetary policy and readjusting the budget. It will largely ignore the more urgent problem of youth unemployment, a critical trigger for the revolution in 2011.  Of the total unemployed in Egypt, 74% are between 15 and 29.

As the months have passed, Egypt’s economic crisis has deepened, leaving it with little cash to invest in jobs and address the country’s biggest problem of unemployment.

Ultimately, donors should consider investing in job training for youth, and in small and medium sized businesses earlier and before an IMF loan is signed.

International donors cannot keep waiting for an IMF loan agreement before helping Egypt, which has run out of cash to help itself at this point. If Europe and the US is so keen to help with the country’s most pressing problem, then soft loans and aid will be unlocked in the next month or two. 

The chief executives of Egypt’s biggest investment bank, EFG Hermes, have been quietly replaced as the bank attempts to clean up its image ahead of a potential takeover from Qatari firm Qinvest, three sources close to the matter have said.

Hassan Heikal and Yasser El Mallawany, who were last year charged with alleged insider trading alongside the sons of the former Egyptian President Hosni Mubarak, are still “technically on board but have been removed from the executive function,” said one investment banker close to the bank. Mr Heikal and Mr El Mallawany are still getting a paycheck but remain in their positions only on paper, the banker said.

EFG Hermes denied any changes were made. The changes have not yet been officially announced and Mr Heikal and Mr El Mallawany are still employed as CEOs at EFG Hermes.

Karim Awad and Kashif Siddiqi, who were last year announced as the new co-CEOs as part of the Qinvest takeover, are now running the bank, a second banker said.  They were head of Investment Banking and head of Asset Management respectively.

Under Qinvest deal, Mr El Mallawany and Mr Heikal were to leave on completion of the transaction that would see Qinvest take control of the bank.  But the deal has stalled because of delays in getting government approval in some Arab countries, according to a statement from EFG in January.

Mr Heikal, who has been living in London for at least a year, is now “pursuing other opportunities” and is “definitely not involved in the running of EFG,” a third source said.

A registry form at the Dubai International Finance Centre in the United Arab Emirates, where EFG Hermes is also registered, lists Mr Awad and Mr Siddiqi as the new directors.  Mr Heikal and Mr El Mallawany are listed as former directors, ending their position in June 06 2013, just 7 days after the case of alleged insider trading was brought against them in Cairo.

In addition, EFG Hermes main website also suggests changes at the helm.  As of February 16, the website title Karim Awad as Co-chief executive of the investment bank, and lists him first in the ranking on the profiles page. But this change was made only a week ago, when the website had described him under the old title of  head of investment banking.

The change is subtle, but indicates a significant shift in the bank’s executive management.

EFG has seen a sharp drop in its market value since the turmoil of the 2011 uprising in Egypt, partly because of its association with Gamal Mubarak, son of the former Egyptian president who owned a stake in its private equity business.

A further shadow was cast over EFG when its two co-chief executives, Mr Heikal and Mr El Mallawany, were among the nine alleged to have made an illegal profit of more than 2 billion Egyptian pounds ($331 million) through corrupt stock exchange transactions last May. The case is ongoing.

Arab economies have become addicted to “unearned income streams” including fuel exports, foreign aid, and remittances. This fragile social contract has led countries across the Middle East and North Africa to increase subsidies on fuel and food at times of social unrest.

This is their ”original sin” and is fast becoming a liability, say economists Adeel Malik and Bassem Awadallah in this important paper for the World Development journal recently made available to the public.

“External revenues—whether derived from oil, aid, or remittances—profoundly shape the region’s political economy” which only serves to “stifle economic and political incentives, turning economies away from production to patronage”.  

So as a result, on a per capita basis, the Middle East and North Africa received the highest overseas development assistance in 2008 ($73 compared to $49 in sub-Saharan Africa), the paper says. North Africa has consistently been the largest recipient of net aid per capita since 1960s (see table). These aid flows are largely driven by geo-political considerations.

The authors point out that despite the differences in cultures, economies and geographies across the Middle East and North Africa (Algeria to Syria for example), there are “at least five common denominators that cut across commonly recognized conceptual boundaries—for example, whether an Arab state is a monarchy or a republic, labor-scarce or labor abundant, resource-rich or resource-poor”.  One of these is the dependance on exports and aid. They spell out the other connecting factors:

First, all across the Arab world both economic and political power is concentrated in the hands of a few.

Second, the typical Arab state can be characterized as a security state; its coercive apparatus is both fierce and extensive.

Third, the broad contours of demographic change and the resulting youth bulges are fairly common across the region.

Fourth, Arab countries are mostly centralized states with a dominant public sector and, with few exceptions, weak private enterprise.

So what went wrong?

Malik and Awadallah go back to the Ottoman empire where centralized bureaucratic rule worked hard to prevent the emergence of autonomous social groups, and therefore valuable and profitable connections across the region and a strong private sector:

The Arab world has inherited an unfavorable and divisive legacy. The roots of a weak private sector run deep in history. Merchants were politically weak under the Ottomans.

A robust private sector was more feared than favored. When business thrived, it remained effectively in the hands of foreign merchants and local minorities. This was politically expedient: foreign merchants benefited from the economic privileges granted by rulers, but
seldom challenged their authority.

The break-up of the Ottoman Empire into a multitude of independent states created new political boundaries, but, over time, these became permanent economic boundaries.

The consequence of this divide meant that when globalisation was unavoidable, Arab economies did not integrate with one another but only with global structures of trade and finance.  It’s no surprise then that trade agreements in the Mena region are well below the global average.

The key concluding questions is: can the region harness its natural geographic strengths to build a future based on trade and production, or does it fall back on the geography of rents and patronage?  Access to the coast, Europe and a large labour force are attractive opportunities that emerging markets would jump at. So why has the Arab world failed to integrate?

Revolutions across the region are an “apt reminder that the prevailing model has reach its expiry date”, they say.

“This model built on oil and aid fortunes—and a leviathan state—is fast becoming a liability.”

Late one night in November 2010, a plane carrying dozens of Colombian men touched down in this glittering seaside capital [Abu Dhabi]. Whisked through customs by an Emirati intelligence officer, the group boarded an unmarked bus and drove roughly 20 miles to a windswept military complex in the desert sand.

The Colombians had entered the United Arab Emirates posing as construction workers. In fact, they were soldiers for a secret American-led mercenary army being built by Erik Prince, the billionaire founder of Blackwater Worldwide, with $529 million from the oil-soaked sheikdom.

By Mark Mazzetti and Emily B. Hager for The New York Times, Secret Desert Force Set Up by Blackwater, May 2011

For any expatriate who has spent time in the United Arab Emirates, the luxury lifestyle soon gives way to a seedy underworld, which is only a paradise for fugitives on the run.

The UAE, after all, is “an autocracy with the sheen of a progressive, modern state”, according to the New York Times’ reporters who exposed Erik Prince, the founder of Blackwater, and his secret army.

But for the Colombians he recruited for the battalion intended to beef up the UAE’s military presence, Abu Dhabi is the “Arabian Dream” offering a better quality of life. 

Prince, who had already been a driving force in the boom in wartime contracting that began after the September 11, 2001, attacks, was hired by the crown prince of Abu Dhabi, Sheikh Mohamed bin Zayed al-Nahyan, to put together a squad of foreign troops for the UAE.

He outsourced critical parts of the UAE’s defense to mercenaries from countries including Colombia and South Africa, in a plan said to have been drafted months before the so-called Arab Spring revolts that many experts believe are unlikely to spread to the UAE. But Iran was a particular concern.

The mercenaries live in a training camp, located on an Emirati base called Zayed Military City:

It is hidden behind concrete walls laced with barbed wire. Photographs show rows of identical yellow temporary buildings, used for barracks and mess halls, and a motor pool, which houses Humvees and fuel trucks.

Secret Desert Force Set Up by Blackwater, May 2011

It does not sound like much, but for these imported soldiers, joining the operation was an opportunity to earn a lot of money and see a new part of the world.

This week, Columbia’s daily newspaper EL TIEMPO, gained exclusive access to some of the Colombian paramilitaries who spoke of the “Arabian Dream” in the UAE. 

For the 1,400 Colombian troops in Abu Dhabi, the UAE offers “not just a medal, but a proper paycheck”, according to a translation of the Spanish article.

“Why did we decide to leave? That’s what people ask us. The response is easy: Quality of life,” they [the troops] say.

Colombianos en busca del sueño árabe, El Tiempo, February 2013

One officer describes the stark difference in quality of life. In Columbia, he received a bonus of 800,000 pesos ($448.8). In Abu Dhabi, he has a salary of $3,000, receives housing, food and healthcare free. He has also learnt English, and in the evenings, he and his colleagues travel in buses into the city centre, where they can buy food and supplies. They get weekends off.

The long weeks of combat, sleepless nights, patrolling and watching for landmines were left behind, the officers told EL TIEMPO.

Reflex Responses, a company known as R2 and contracted by the UAE government to train and recruit the troops, spends roughly $9 million per month maintaining the battalion, which includes expenditures for employee salaries, ammunition and wages for dozens of domestic workers who cook meals, wash clothes and clean the camp,  according to the NYT report.

The Colombians “never wanted for anything”, said Calixto Rincón, a 13-year veteran of Colombia’s National Police force who is now back in Colombia after serving as a mercenary in the UAE.

The UAE and American leaders even arranged to have a chef travel from Colombia to make traditional soups.

“Here, you can’t look at the women like in Colombia, because you can end up in jail,” one officer told EL TIEMPO. “A wrong glance can create offense, which gets reported to the police”.

Meanwhile another told the New York Times: “We didn’t have permission to even look through the door. We were only allowed outside for our morning jog, and all we could see was sand everywhere.”

The monthly announcement of Egypt’s net international reserves figure has become more of a spectacle of the country’s economic woes than a reflection of recovery.

Egypt’s foreign reserves have tumbled more than 60% from $36 billion before the uprising that toppled Hosni Mubarak in early 2011 and as the country’s key sources of hard currency – investors and tourists – have dried up.

Reserves rose slightly to $15.5 billion helped by a deposit by Qatar to support the economy, Egypt’s minister of finance said yesterday, but they remain at a dangerous level after being run down to defend Egypt’s currency.

Though sporadic official announcements convey seemingly unwavering optimism that reserves will be back to normal levels, behind these headline numbers is a more worrying figure.

In reality, liquid reserves, or convertible foreign currencies including securities, cash and deposits that can be used to defend the Egyptian pound, are at $11.8 billion, according to Egypt financial consultancy Dcode, which used data from the Egyptian Central Bank.

According to Dcode:

Liquid Net International Reserves (net of Gold reserves) declined from $21.3 billion in September 2011 to $11.8 billion in November 2012, covering only 2.2 months of commodity imports.  This figure includes past debt repayments, including a $1.6 billion debt repayment in July, but does not include any other repayments post-November 2012.

That suggests the Central Bank’s monthly announcement is extremely misleading and in fact Egypt is well below the three months of cover for imports that the IMF recommends its members retain.

But not only have economists suggested liquid reserves are falling at a faster rate than net international reserves, but that the $11.8 billon could be even lower in reality.

In a November 2012 note, Capital Economics economist William Jackson suggested liquid reserves are under $10 billion:

Jackson writes:

The CBE has intervened aggressively in the foreign exchange market to defend the pound against the backdrop of capital flight. As a result, FX reserves have fallen from a peak of $36.2bn to just $15.5bn at present (and liquid reserves have fallen even further). (See Chart 1.) The good news is that the CBE’s reserves have stabilised in recent months, mainly thanks to the drip feed of aid from the Gulf. And so long as the IMF deal is ratified by the Fund’s board next month, the Bank’s reserves should receive a more sizeable boost in the coming months.

As liquid reserves run dry, the Central Bank’s ability to defend an already overvalued pound has become untenable.

With no sign of a final agreement on the IMF loan, the Bank’s decision to launch dollar auctions (which many regarded as a late reaction) to effectively depreciate the pound makes a lot of sense.

Even more intriguing is the IMF’s own breakdown of Egypt’s reserve level.

The IMF figures suggest that the bulk of Egypt’s liquid reserves, excluding gold and other non-convertible assets, stand at about $7.1 billion.  That’s in stark contrast to the Central Bank, which says foreign currency reserves are $10 billion. That $7.1 billion figure may not represent the only liquid reserves but economists say they are unsure of what this level could be at the moment.

The Central Bank’s late decision to allow the pound to fall has cost the country and the Morsi administration.

Now Egypt has little choice but to rely on immediate, easy aid from the Gulf, and a long-term (and very contentious) loan from the IMF before it can recover to its original reserves level.

A NEW EGYPT 

Once upon a time, Mohammed Morsi’s election as President of Egypt invoked nationwide pride, celebration and relief that finally stability might be on its way. Many may not have voted for him, but at least they could rest easy that the military generals were out of power and the democratic process was underway.

“I have no rights, only responsibilities,” Morsi said to cheering crowds chanting, “God is great”.

“If I do not deliver, do not obey me.”

Half a year later and his words have come back to haunt him. The economy has deteriorated so much that even the Central Bank has warned of a critically low level of foreign reserves. People are panicking and rushing to trade their pounds for dollars.

To the detriment of the population, today’s Egypt is not dissimilar to the country ruled under former president Hosni Mubarak.  The Morsi administration, like Mubarak’s regime, is struggling to win legitimacy from the people and contradictions on the path ahead have confused the international community.

Mubarak began his presidency in much the same way as Morsi. He won the support of the nation by releasing prominent political prisoners and removing some restrictions on the media.

He also took the step of inviting the country’s most prominent economists to a conference to discuss the deteriorating condition of the Egyptian economy and displayed genuine will for economic reform. (Morsi is soon planning a “National Dialogue” on the economy).

Sadat had left behind a heavy burden of high levels of foreign debt and high inflation. Egypt’s economic structure was askew.

And in Mubarak, who appeared less domineering and egotistical than his predecessor, there was hope in the hearts of Egyptians that change was coming. But it was clear within a year of his inauguration that it was not meant to be. The emergency law was renewed and reforms slowed to a glacial pace.

“Sure enough”, wrote Galal Amin in the introduction of Egypt in the Era of Hosni Mubarak, 1981-2011 “the sky began to darken and little by little we began to despair of any real political or economic change occurring”.

The honeymoon was over and Egypt seemed forever destined to be a “Soft state”, or:

“A state that passes laws but does not enforce them. When the state is weak, taxes are not collected, people are left to break the law, they lose respect for the police, traffic laws are flouted, and security is lax,” wrote Amin.

Arabist John Waterbury saw the soft state as increasingly ingrained into the fabric of Egypt. In The “Soft State” and the Open Door, he wrote:

“Egypt, whether under Nasser or Sadat, has been a soft state. Neither leader felt it was necessary or desirable to sweat significant segments of the citizenry for the sustained savings that might have made relatively autonomous growth possible.”

This sad situation has repeated itself with Mubarak, and now it seems with Morsi.

Egypt’s only hope now is for the president to begin to reform the creaking bureaucracy and ease an unsustainable subsidy regime, while attracting investment and creating new jobs to lessen the blow. It won’t be easy, but it is the burden of a president to do what must be done even if it hurts the reputation of his political party.

That should be the theme of 2013. But the lack of a clear economic vision is worrying, as Nadine Marroushi, a Cairo-based reporter for Bloomberg, and I will explore through themes that cover the long-winded negotiations with the International Monetary Fund, the costly addiction to energy subsidies and the rise of the labour movement.

Happy New Year.
Farah
Editor, Rebel Economy

ECONOMIC GROWTH FORECASTS

Egypt’s government has said it will focus on boosting flagging economic growth to 3.5% this financial year and 4.5% in 2013/2014.

That is a scaled down version of a previous forecast for growth of between 4% to 4.5% for 2012/2013.

The economy, riven with political and economic strife, has struggled to grow as the uprising that toppled Hosni Mubarak in February 2011 chased away tourists and investors.

Still, the economy grew by an annual 2.6% in the third quarter of 2012, President Mohamed Morsi said in a televised speech this week.

In the year that ended June 30, gross domestic product grew by a lacklustre 2.2%, up from 1.8% in the 2010/11 financial year, according to statistics published by the Finance Ministry.

This compares with annual growth rates of 5% and higher before the regime of Hosni Mubarak was overthrown in 2011.

Rebel Economy surveyed seven economists and two financial analysts that on average said the economy would be hard pressed to grow above 2% in the next financial year.

Most have pencilled in growth of between 2% and 2.5% in the next financial year.  There are anomalies however in forecasts, with one chief economist at a Cairo-based investment firm saying the nation could experience “significant” growth of 6% or 7% next year if the IMF loan is signed. The agreement would unlock at least $14 billion of financing in other loan packages and would provide the stimulus needed for growth, he said.

All those interviewed agreed that the IMF loan is the cheapest and most effective catalyst for an economic revival. The relatively easy 1.1% interest attached is far more  favourable than expensive government bonds and bills the state has sold to try to narrow the deficit.  These have been sold at yields as high as 16%. Now, the interest payments on Egyptian government bond yields are increasing at a faster rate than spending on subsidies and wages.  Economists say these payments now make up around 15% of government spending.

The heavy burden on banks to buy these securities has also diverted cash that would have been spent in the private sector on narrowing the budget deficit.

Due to the significance of the IMF loan for an economic recovery, Rebel Economy has laid out three potential scenarios based on the negotiations giving some indication of what could happen in the months to come and the impact on elements of the economy including the currency.

THREE SCENARIOS BASED ON IMF LOAN NEGOTIATIONS 

SCENARIO 1: IMF loan is passed in early 2013 (Jan or Feb)

The most favourable of all scenarios would see the IMF agreement officially signed in January.  Under this scenario, the one month delay would have little impact on Egypt’s economic framework presented to the IMF which includes a package of measures to cut wasteful spending and earn revenue. In a reassuring sign, Egypt’s prime minister Hisham Qandil latest statements indicate that negotiations will resume in January.  Qandil told reporters there won’t be any fundamental changes in their economic plan with the IMF.

This would mean that Egypt would immediately have to go ahead with a package of reforms it has proposed to appease the IMF, including tax hikes and subsidy reforms before or as soon as the loan agreement was signed.

These unpopular economic reforms will be difficult to implement two months before the parliamentary elections when the Muslim Brotherhood hopes for significant support. Reforms will be particularly hard to implement because of the president’s slim mandate.  Morsi’s decision to rush ahead with a vote on the constitution despite calls from the opposition to delay it left him with a polarised country.

However, if the government implements these reforms in the right way – by communicating the “Hows” and “Whys” – the loan will go some way to relieving pressure on the currency and foreign reserves. The steady depreciation of the pound will be stemmed and the rush to swap pounds to dollars will also ease off as the public sees a light at the end of the tunnel.

Economists at Beltone have forecast an additional drop in reserves to about $14 billion in December, or the equivalent of 2.8 months of imports, well below the “safe” level.

Therefore, an injection of almost $5 billion would instantly provide a buffer to the Central Bank and the budget. More importantly, the IMF loan will act as a catalyst for the release of other loans that are contingent on this agreement being signed. Economists say that this additional support amounts to about $14.5 billion. Finally, a final agreement on the loan would end almost two years of negotiations and would draw a line under the uncertainty that has stopped foreign investors from returning to Egypt.  The loan, more symbolic than financially helpful, would signal a new start for the nation.

SCENARIO 2: Loan delayed again, forecast for resuming negotiations

Given that increasing taxes on goods and services is a prerequisite for signing the final agreements on the IMF loan, it is a possibility that the government will attempt to further delay unpopular measures until after the parliamentary elections, which are due around February.

This could initially put pressure on the pound and budget deficit.

With tourism and foreign direct investment down, two of Egypt’s main sources of foreign currency, its ability to continue propping up the pound through foreign reserves will come under further pressure.

The central bank already appears to be letting the pound slip gradually. It not only hit a near eight-year low on December 26, but its value has been declining faster than usual in December. The pound has been stable and traded at around 6 pounds to the dollar for the first half of the year, only to start falling after Egypt signed a preliminary IMF loan agreement in mid-November.

Money to support the budget deficit from the EU and African Development Bank will also continue to be delayed so long as Egypt delays the IMF loan, and investor confidence will continue to be low.

This paves the way for Egypt to receive financial support from other actors, such as the Gulf states or the army — as it has done over the last two years — at least until parliamentary elections.

Though, with the politically charged atmosphere created by the constitution, the reinstatement of Parliament is no guarantee that the government will be any more likely to pass its planned austerity measures.

SCENARIO 3: Loan delayed with no forecast for resuming negotiations

Under this scenario, Egypt’s economy is most fragile.  Domestic and foreign investors (individual and institutional – i.e. large companies) are likely to exit the debt markets and swap their pounds for dollars.  The government will lose support from international donors who have waited for the IMF loan to pass, and much-need aid will pass by Egypt.

The country’s currency devaluation may be “disorderly”, according to this research note from Capital Economics:

“Failure to secure help from the IMF would make a disorderly devaluation more likely. In this scenario, the pound could overshoot, falling by perhaps 50% or more against the US$. The costs to the economy would be severe.

This is likely to lead to a spike in inflation, sharp hikes in interest rates, a potential banking crisis and rapid fall in asset prices.”

Higher inflation and a cheaper pound will be hardest for the poorest, who are already struggling in their daily lives.  Food will become expensive and meagre salaries will buy less.  A “Revolution of the Hungry” could lead to the revival of riots, political instability and public discontent with the Morsi administration.

Investor confidence will also be shaken in the short-term by the uncertainty created regarding Egypt’s economic plan and the government’s ability to get things done. A repeat of January 2011 could see companies scaling back or sitting out the crisis, and foreign direct investment could likely fizzle out.

The government will most likely try to press ahead with austerity measures, even without the prospect of signing an IMF loan agreement to get the budget under control, though pressure from political opposition forces will make it difficult to enact these reforms.

As Reuters reports, by “fast-tracking the constitution to a referendum that the opposition said was divisive, he [Morsi] may have squandered any chance of building a consensus on tax rises and spending cuts that are essential to rein in a crushing budget deficit.”

It is likely that with no agenda for resuming negotiations with the IMF, Egypt would have to go back to the drawing board and alter its macro-economic plan to accommodate the changing fiscal situation.  Government officials say this could happen even when Egypt resumes negotiations with the IMF in January.

KEY CHALLENGES
Aside from the task of securing the IMF loan, Egypt faces a multitude of other significant challenges. Rebel Economy broke these down into a few major themes: the labour movement, tax reform, energy subsidies and the rule of law.

The Labour Movement

Egypt has experienced an increase in labour action since the outbreak of the revolution. Protests have forced factories and companies to shut down, which has shaken investor confidence and highlighted the need for more effective laws that govern employer-employee relations.

“There have been more strikes than ever before,” says Joel Benin, an academic who has written extensively on Egypt’s labour movement. There were 1,400 strikes and forms of collection action in 2011 alone, compared with no more than 800 in any previous decade, Benin estimated.

The main demand has been for the implementation of a minimum wage (ranging between 1,200 and 1,500 Egyptian pounds), better working conditions and recognition of Egypt’s newly formed independent unions.

A draft labour law, introduced by Ahmed el-Borai, the former labour minister, allowed unions to organise for the first time beyond the parameters of the government-controlled Egyptian Trade Union Federation. But there have been delays in fully enforcing the law, leaving workers in legal limbo, the Financial Times reported.

In 2013 the Shura Council, which now has legislative powers, or the lower house of Parliament, if re-elected as planned, could re-visit this.

Strikes have been increasingly effective. In three of the most recent strikes, at DP World’s Ain Sokhna port (a private company),  Eastern Tobacco and Arab Polvara (both public), demands were eventually either fully or partially met.

The key challenge for employers, especially in the private sector, will be accepting that even if they spend a bit more on workers by implementing a minimum wage, the labour force in Egypt is still much cheaper than its regional competitors in Turkey, Morocco and Tunisia, and certainly Europe.

The government will need to introduce a labour law that satisfies workers’, unions’ and employers’ needs. It shouldn’t try to dominate the labour union movement and should avoid criminalising protests or responding with any heavy-handed measures, which would be counter-productive in the unrest it ensues.

Energy Subsidies

After years of debate, cutting one of Egypt’s biggest bills has become essential to balancing the nation’s financial books.

The government spends about 20% of its budget on keeping fuel prices down for the general public in a subsidy system that benefits the richest rather than the neediest.  Now, Egypt is one of the worst offenders for energy subsidies in the world on par with Russia and China.  And because its domestic consumption is rapidly growing, Egypt winds up using its share of production locally rather than earning much-needed revenue from exports. That means it buys expensive fuel from abroad and sells it at a discounted price domestically.

The country has shifted from being a net exporter to a net importer of oil over the past decade.  This month Egypt’s petroleum ministry admitted it had also switched to a net importer of gas from a net exporter.  The consequences of such an unsustainable practice are immense.

On a domestic level, fuel is so cheap that almost everyone uses their car to get around and congestion and pollution are normal.  In addition, the government spends more on energy subsidies that health and education combined so the social impact is enormous.  More worrying still is the rising (external) debt pile. The nation sells its fuel at a much cheaper price than it buys it so inevitably debts to international and domestic energy companies and banks grow.

Bankers that have interests in energy have told Rebel Economy repeatedly that energy subsidies are at the crux of Egypt’s wider problems. Reserves have been depleted not only to support the pound but to keep importing petroleum products to keep up with demand.  The Central Bank released a statement this week saying it had spent $14 billion since the beginning of 2011 on imports of petroleum products and foodstuffs.  Undoubtedly, this was to plug a shortage in the market. 

So what can be done? What is clear is that everyone now regards energy subsidies as a drain on the budget and politicians acknowledge that reforms have to be made. But not much has come of the countless promises to enforce reforms including a coupon system that would better regulate subsidies and fuel price hikes that would instil a healthy aversion to buying gallons of fuel.  So far, the Morsi administration has shown it is too weak to implement difficult reforms for fear of riots and a backlash.  With two months before the parliamentary elections, it appears that Morsi must choose between temporary popularity by retaining the status quo of these plentiful fuel subsidies, or steer the nation out of its crisis and show a strong hand.

Tax Reform

The fact that Morsi couldn’t implement a hike in sales tax on alcohol in a country that is mostly dry shows what an uphill struggle his government faces in carrying out tax reform.

The government recently announced a package of tax hikes on goods and services, ranging from cigarettes and mobile phone calls to electricity bills and real estate. Within hours, the reforms were delayed amid calls for “societal dialogue” by members of the opposition and media.  The delay was also seen as an attempt to win the popular vote at a politically sensitive time when Egyptians were set to vote on the constitution.

The move had more severe impacts, however. Egypt had to postpone the signing of the IMF agreement partly because tax reforms are a crucial part of the economic reform programme presented to the Fund. Without these tax hikes, it is unlikely the IMF would have agreed to disburse $4.8 billion.

Raising taxes is necessary to shore up finances and plug a budget deficit that reached 11% of GDP in the fiscal year that ended June 2012, and is projected to exceed 10% by June 2013.

But Morsi and his aides have yet to gain broad support on the matter with members of the opposition, a task that is necessary but hard to imagine given their poor track record in consensus building with non-Islamists.

Other tax measures, such as reforming the 20% income tax on wages whether rich or poor, as well as addressing corporation tax and broadening the tax base, are to be taken up by the next Parliament.

Rule of Law

There is an ongoing concern about respect for the rule of law in Egypt, which is critical to address before returning to stability.  For example, the people blocking Tahrir Square believe the government is illegitimate so they illegally block traffic. Police, too, haven’t won back respect from the people, so they are unable to enforce the law sometimes.

As for the new constitution, though it spells out the new parameters for the rule of law, many people believe those parameters are incorrect. Max Rodenbeck spelled out the key flaws in this Economist report. The new constitution could give “Morsi’s party, the Muslim Brotherhood, a grip on power not unlike that enjoyed by Mubarak”, he writes.

The somewhat unpopular new constitution and a government still trying to win legitimacy from people means there is a rule of law crisis in Egypt.  As Haitham Tabei writes in EgyptSource:

“Solutions must be found to the [rule of law] crisis, outside the current framework of religious institutions and inept security forces, and must depend instead on a state of citizenship, which guarantees the safety and protection of all its citizens regardless of religion.”

MAIN DRIVERS OF GROWTH

These challenges, though significant, are not impossible. Egypt’s geostrategic position on the crossroads of Europe and Africa, its large population and favourable tax conditions are all drivers of growth and mean the nation will continue to attract companies that want to tap the retail market, quickly. European banks, hit by the Eurozone crisis have had to offload assets in Egypt but these assets have caught the attention of Gulf banks, despite the political instability.

Société Générale has agreed to sell its majority stake in NSGB, its Egyptian subsidiary, to Qatar National Bank for $2 billion. BNP Paribas seeks bids for the sale of its Egyptian retail arm, which is expected to generate between $400 million and $500 million. Last year, Standard Chartered came close to acquiring the Egyptian assets of Greece’s Piraeus Bank.

Other merger and acquisition activity in the retail market is likely to continue in 2013.  We are already seeing signs of this happening with Dubai’s Majid Al Futtaim in talks with Egypt’s Mansour Group, owned by billionaire Mohammed Mansour, to buy its supermarket business in a deal valued at $200 million to $300 million.

Enacting a law that would allow issuance of Islamic bonds, or sukuk, is also seen as one driver for investment growth next year, economists say. A sukuk law has been mooted for several years but only taken more seriously after the revolution when Islamist parties have lobbied harder for Islamic financing. Globally, $109 billion worth of sukuk were issued in the first nine months of 2012, up 69% from a year earlier, with the rise driven primarily by Malaysia and Gulf governments, according to research by Zawya.  Egypt is yet to tap into this lucrative market.

Above all, economists say another driver of economic growth will be resolving investment disputes post-revolution. Egypt’s biggest companies, especially those in the property sector, have faced legal challenges because of Mubarak-era contracts. More recently contracts in some of the industrial sectors, including goldminer Centamin have been under the microscope.  Some of these cases are rushed through with little valid evidence and are eventually overturned. A more accurate and thorough approach to investment cases will pave the way for a better corporate structure.

A BROADER VIEW OF ECONOMIC GROWTH 

The great mistake of the Mubarak regime was not seeing its role as broader than just increasing growth. Their policies led to a revived economy, but the profits only stayed with a small elite and did not make an impact on the vast majority.

Economic policy is not just about making some numbers go up and others go down. That is why the definitions are so important. Gamal Mubarak’s cabinet of technocrats lacked the vision to redefine the aspirations of the government.

And that is one area where the Brotherhood’s Renaissance Project team are right. Khaled AlQazzaz, an advisor to Morsi on “integrated development”, explained during a conference earlier this year that the government was planning to change the metrics it uses to evaluate successes and failures. That means they are proposing a new way of looking at how the government improves the lives of Egyptians.

It will no longer just be about the GDP rate and number of teachers to pupils. It will be about whether the lives of Egyptians is improving or not, analyzed through a new set of performance indicators. This way all policies can be directed toward the right solution. The answer isn’t always in more teachers, but changing the curriculum. It’s not about number of hospitals, but about the health of Egyptians.

In New York City, the police department radically changed they way they approached crime by targeting the crime rate itself rather than police officers’ response time to a scene.

New York just reported its lowest number of murders for decades.

The government should go even further and establish an independent ministry to be in charge of the portfolio, so Egyptians know that the numbers aren’t being fudged to make the president look good.

It should also give the opposition movement something to think about. Are their policies just better technical tricks to balance the books or do they have a vision for Egypt that is broader than “neoliberalism without corruption”? This should be the basis of all political platforms: how will you grow the economy and how will you measure the impacts? The answer to those twin questions would give people a good idea of why they should or shouldn’t vote for them.

CONCLUSION

With little of its own money to spend, Egypt will be forced in 2013 to implement belt-tightening measures on stomachs that are already hungry.

The cries for “bread, freedom and social justice” continue to echo in protests that have not ceased since the 2011 uprising.

But austerity measures are difficult enough to implement in a country with political stability let alone one that is as polarised as Egypt. Strict reforms will undoubtedly stoke further unrest in the year ahead.

It does not help that the government consistently fails to consult the public about its plans in a transparent manner, or when it puts out decisions only to backtrack hours later. Transparency is crucial.

State institutions also contradict themselves in the information they put out, and state media is biased, all of which creates a climate of uncertainty and mistrust in government.

It is now or never for Morsi.

He has two paths to choose from: retaining the status quo or leading the country out of the crisis with a strong hand, clear communication and a promise to soften the blow for the most vulnerable. He has the power to implement reforms that will begin to change the lives of millions of people who are suffering from decades of neglect.

Can Morsi make the first, difficult steps of change not seen in the country for decades? Will he be strong and bold enough to lead the country out of its economic, social and political malaise? 2013 will be the test.

Egypt’s Central Bank yesterday published a strangley frank statement that sheds light on the country’s terrible spending habits and signals how the Morsi administration is losing its grip on the economy. 

Just hours after the country’s president Mohammed Morsi made a speech to declare the economy was showing signs of improvement, the Central Bank said it plans to start foreign-exchange auctions in order to preserve foreign reserves after they plunged to “minimum and critical” levels.

With help from Bradley Hope, The National newspaper’s Cairo bureau chief. 

Egyptian President Mohammed Morsi has proved to be a recalcitrant negotiator with the opposition movement in Egypt over the past month, raising questions about the sudden move toward magnanimity in his speech Wednesday night where he appealed for calm and national dialogue.

Politically, he may be trying to seal the issue of the constitution once and for all through some compromises. (It passed with slim approval by 63.8 per cent of voters and only about a third of registered voters took part in the referendum).

But a bigger concern for the president and his Islamist supporters is the economy. The reputation of the Muslim Brotherhood’s new political power is on the line. The last thing the group wants is to be the stewards of a full-blown economic crisis, something that could tarnish their reputation and electoral viability in years to come. If Egypt remains unstable, foreign donors will be wary of lending, investors will wait on the sidelines and tourists will stay away.

In the short-term, the Egyptian pound has moved to centre-stage. It hit a near eight-year low on December 26, dropping to LE6.175 per dollar. It has slowly declined over the past two years from about LE5.7.

Monetary policy and impacts of a currency devaluation – which many are predicting as imminent – can be bewildering, so Rebel Economy has prepared this explainer.

Let’s start from the beginning. What is a currency devaluation? 

The textbook definition of a currency devaluation, according to Investopedia, is:

A deliberate downward adjustment to a country’s official exchange rate relative to other currencies. In a fixed exchange rate regime, only a decision by a country’s government (i.e central bank) can alter the official value of the currency. Contrast to “revaluation”.

A devaluation is a policy decision by the government, as opposed to a depreciation, which happens when a free-floating currency reacts to market forces.

Although Egypt officially floated the pound in 2003, it has a policy of managing the pound in what is known as a “managed float rate regime”. That means that the currency rate fluctuates, but is ultimately managed by the Central Bank of Egypt through capital controls and trading of foreign currencies.

The Central Bank’s primary tool of supporting the domestic currency is by using the country’s reserves of foreign currency. In short, it has to be willing to meet all of the offers to sell Egyptian pounds at the established rate to keep it at the level it wants.

That means the pound’s nominal exchange rate has remained almost unchanged since 2004.

So, what’s the problem? 

The Central Bank cannot carry on using its foreign reserves for much longer.

The Central Bank’s policy has led to a rapid decrease in foreign reserves to just $15.04 billion from $36 billion in late 2010, a dangerously low level that is just enough to cover three months worth of imports.

The two most important sources of foreign currency (which would normally keep foreign reserves replenished), tourism and foreign direct investment, have dried up because of Egypt’s economic crisis.

Tourism revenues have declined by about a third and foreign direct investment was just $2.5 billion in the first half of 2012 versus $4.1 billion in the first half of 2010, according to the UN.

GDP growth has slowed to 2.2%, from annual rates of 5.5% before the revolution, and unemployment has increased to 12.6%.

The Central Bank has not been able to hold off a depreciation and the pressure on the pound from continued political instability has reached crisis point.   Egyptians are swapping their pounds for dollars in a process better known as “dollarization”, exacerbating the depreciation of the pound, and meanwhile the Central Bank is struggling to fight against market forces that are pushing the currency down.

Why does Egypt want to protect its currency?

Protecting the currency prevents a scenario where real wages decline. (The actual wage for a professor, for example, would stay the same but he or she would be able to buy less with the salary if the currency depreciated).

A depreciated currency would also lead to a rise in exports (because they would be cheaper for foreign buyers) but a decline in imports (because they would become more expensive for domestic buyers). Finally, inflation would rise more quickly with a cheaper pound. In general, it would lead to a more difficult period for Egyptians, especially for those who are already suffering the most.

Analysts have been predicting for more than a year that Egypt would be forced to devalue the currency when it no longer had enough reserves to prop up the pound. The question, they have said, is only when it would happen.

A forced devaluation can also happen merely due to speculation on the market and the perception that a devaluation is coming. If everyone panics and tries to exchange their pounds for dollars, which is already happening in Egypt to some extent, then the level of foreign reserves will decline even more rapidly.

This can cause a balance of payments crisis, which occurs “when a nation is unable to pay for essential imports and/or service its debt repayments”. Other consequences of a devaluation include an increased cost of borrowing from abroad.

“If reserves are depleted, the government would need to start borrowing to buy commodities, pushing prices higher and demand lower, and risking a currency explosion similar to what happened in 2003. That could lead to stagflation, a period of high inflation and slow growth.”

From AmCham Magazine

What impact does the IMF loan have on the currency?

The International Monetary Fund’s $4.8 billion loan package to Egypt would act as an important stimulus for providing more foreign currency to protect the pound, but it has now been delayed by President Morsi.By many accounts, he believed the country was not yet ready for the austerity measures (higher taxes and lower subsidies) that are part of the economic programme created by Egypt to appease the IMF.

Without the IMF loan, a devaluation may be “disorderly”, according to this research note from Capital Economics:

“The key question is whether the necessary devaluation is orderly or disorderly. Failure to secure help from the IMF would make a disorderly devaluation more likely. In this scenario, the pound could overshoot, falling by perhaps 50% or more against the US$. The costs to the economy would be severe.

This is likely to lead to a spike in inflation, sharp hikes in interest rates, a potential banking crisis and rapid fall in asset prices.”

The IMF is not the only potential saviour for Egypt’s economy. It is supported by the US and Qatar, among others, who could also step in to support the government in the event of a dire crisis.

Benefits/Disadvantages of controlled devaluation:

Many economists have also called for Egypt to initiate a devaluation to restore balance in the economy and make Egypt more competitive globally.

A devaluation can help reduce the trade deficit because exports typically rise. Right-siding the economy could also ease the need to keep borrowing money to plug gaps in the budget.

The IMF is a lumbering, technical organization, but a good insight into their thinking in unusually clear terms can be found in their lessons for teenagers. It is important to note that many development economists have sharply criticised the IMF because its solutions have made the situation worse in developing countries. Joseph Stiglitz famously said the IMF “was not participating in a conspiracy, but it was reflecting the interests and ideology of the Western financial community”.

“A key effect of devaluation is that it makes the domestic currency cheaper relative to other currencies. There are two implications of a devaluation.

First, devaluation makes the country’s exports relatively less expensive for foreigners. Second, the devaluation makes foreign products relatively more expensive for domestic consumers, thus discouraging imports. This may help to increase the country’s exports and decrease imports, and may therefore help to reduce the current account deficit.

A significant danger is that by increasing the price of imports and stimulating greater demand for domestic products, devaluation can aggravate inflation. If this happens, the government may have to raise interest rates to control inflation, but at the cost of slower economic growth.

Another risk of devaluation is psychological. To the extent that devaluation is viewed as a sign of economic weakness, the creditworthiness of the nation may be jeopardized. Thus, devaluation may dampen investor confidence in the country’s economy and hurt the country’s ability to secure foreign investment.

Another possible consequence is a round of successive devaluations. For instance, trading partners may become concerned that a devaluation might negatively affect their own export industries. Neighboring countries might devalue their own currencies to offset the effects of their trading partner’s devaluation.”

From The IMF In Action: How Can the IMF Help In Time of Crisis?

The worst consequence for Egypt is the prospect of rising inflation. Egypt is a food importing country, so the cost of feeding a family would inevitably increase. This is what political figures mean when they talk of the coming “Revolution of the Hungry”. Many families in poor areas of Egypt are already hard-pressed to afford the unavoidable private education and healthcare costs as well as basic necessities.

A family in Saft el Laban, a poor neighbourhood in Giza, explains in detail how quickly a month’s wages disappear. Said Abdel Hameid, who is married with three children, earns 1,500 pounds a month through two jobs, but most of it is gone within a few days:

“About 500 pounds a month goes paying of his debt for household goods: two fans, an old television and a battered tabletop. Another 25 pounds is paid for a natural gas connection – a rarity for many – that will be amortised over seven years. That does not include the cost of gas used, which averages another 10 pounds a month.

Then comes education costs. The public school system is so dysfunctional that nearly every family in Egypt, poor and rich, pays for private lessons in a bid to improve their children’s’ chances at getting a job. The school of Mr Abdel Hameid’s daughter, Sama, 7, requires 100 pounds a month for after-school lessons. Another 150 pounds is paid for other private lessons from teachers.

Rent for their flat, which consists of two small bedrooms and a living room, is 250 pounds.

That leaves the Abdel Hameid family with about 465 pounds to get through the month. It is barely enough to put basic food on the table. At 5 pounds a kilo, tomatoes are a luxury. To keep up with hungry mouths, the only option is to buy macaroni and rice in bulk. Foul, a boiled bean dish, is a mainstay of their cuisine.”

From The National, August 26, 2012

His income does not include the cost of healthcare, which is supposed to be free in Egypt but the system is so dysfunctional that nearly everyone shells out for private treatment if someone is really sick. The Abdel Hameid family can only pay for medicine if the whole family bands together to raise enough money.

Looking Ahead

No matter what happens in Egypt – an abrupt devaluation, a government-managed devaluation or a continuation of the same Central Bank policy of backstopping the pound – the impacts will be most heavily felt in Egypt’s most vulnerable population. The government has done a poor job of explaining their economic plan for the future (if they have one) and without this, there will be no buy-in from the population, especially if they are afraid of an even worse form of poverty than they already endure. A devaluation is by no means a strategy by itself.

The government must prove that it will take other measures to soften any impacts and get Egypt’s economy growing again. “Renaissance”, which Morsi called for in his speech on Wednesday, is only a word.

What happens when a president of a newly democratic country decides to act more like a tyrannical than post-revolutionary leader? 

It’s clear that it leads to a severe crisis of confidence from the public; the same people that elected this president (albeit, by a narrow margin) to his place less than six months ago.

President Morsi’s decision to issue a decree that granted him far-reaching powers effectively began an avalanche of economic mayhem not seen since the revolution broke out in early 2011.

The swift backflip on this decision did not make any difference, because Morsi had decided to go ahead with a referendum on the constitution, despite calls to delay it.  That has now been passed but there was no landslide victory and Morsi must accommodate a slim mandate that will make it difficult to enforce any economic reform measures.

Above all, the political turmoil that has ensued over the last month has prompted fears that the government is not in control of its finances and the economy.

As a result, fears have grown over the pressure on the pound currency and there has been a rush by Egyptians to withdraw their savings from banks. Initially, the Central Bank sent out a cryptic message of reassurance that it would protect the public’s bank deposits.  

Al Arabiya flashed a headline two days ago:

Then the bank made its move in an attempt to nip in the bud a dangerous path of dollarization, which would put increasing pressure on the pound and the nation’s dwindling international reserves. 

Egypt banned travelers from carrying more than US$10,000 in foreign currency cash in or out of the country. It was part of a presidential decree that modified the central bank law in order to tighten foreign currency transfers amid another wave of dollarization that hasn’t been seen since last year.

AP reports:

The anxiety over the economy was visible at currency exchanges in the upscale Cairo neighborhood of Zamalek, which ran out of dollars by midday and offered only euros — a rare occurrence. Some banks, too, said they had run out of cash dollars, forcing people to seek foreign currency from exchanges around the city.

There were also reports from the local media that an Emirati aircraft delivered cargo loads of cash amounting to $30 million to Egypt to help plug the shortage of dollars.  In another blow, the ratings agency Standard & Poor’s cut the government’s credit rating citing the political turbulence and warning that another cut could come if political problems persist.

The panic prompted a full-scale media management.

The Central Bank of Egypt issued a statement on Monday calling on banks not to listen to rumours circulating about the fiscal health of the nation.

The official English website of the Muslim Brotherhood published an interview with the Freedom and Justice Party’s economist Mohammed Gouda ”refuting rumours” about the economic health of Egypt:

Dr. Mohamed Gouda refuted rumors being persistently reported in print and broadcast media about the poor economic situation in Egypt, pointing out that there is a difference between explaining the economic situation and spreading panic.

“Economic problems can be solved. There is nothing impossible about them. But security and political stability are essential to help the economy and implement the reform plan.”

Well, those aren’t rumours. Egypt is in a dire economic situation and denying this will only prolong the pain.

Finally the prime minister, Hisham Qandil, pointed out the obvious saying political stability was crucial to luring back foreign investors and tourists to help plug the budget deficit and heal the country’s struggling economy.

Meanwhile, Morsi is taking advice from a man that the New York Times described as someone who “frightens most economists”: Hamdeen Sabahi, an outspoken opponent of free-market economic moves in general as well as of a pending $4.8 billion loan from the IMF.

The president made a terrible decision just over a month ago, and now the nation is paying for it. It’s time we saw Morsi making some sacrifices and leading a nation rather than his Brotherhood colleagues.