Egyptian civil servants and IMF technical staff have got to know each other rather well over the past 20 months. They have reached agreements on the policy framework for a loan from the Washington-headquartered fund on several occasions since May 2011 only for the political leadership in Cairo to get cold feet. They are now going over the same ground yet again, trying to salvage a deal that was ready to be signed in December, but which fell victim to the political crisis sparked off by President Mohamed Mursi’s decision to ram through Egypt’s new constitution by appropriating extraordinary powers for his own office.

The IMF loan and other funds linked to it would shore up the balance of payments and rebuild depleted reserves

The repeated delays in concluding an agreement have exacted a heavy economic cost. The IMF loan and other donor funds linked to it would shore up the balance of payments and help to rebuild Egypt’s depleted reserves. The conclusion of an IMF deal would also send an important signal to private investors, laying the basis for a rapid pick-up in real gross domestic product (GDP) growth spurred by new investment. The government’s hesitation stems partly from concerns about the political impact of reforms associated with the IMF agreement, in particular cuts to subsidies and increases in indirect tax rates.

Currency devaluation

Another element of the IMF deal was the exchange rate. Despite denials from officials in the Finance Ministry and the Central Bank of Egypt, it has been long assumed in the country’s business community that a devaluation of 5-10 per cent would be an integral part of the IMF agreement. Market reaction to the latest delays in concluding the deal forced the central bank’s hand at the end of 2012. A new system of foreign exchange auctions went into effect on 30 December after the central bank explained that it could no longer make funds freely available from its depleting foreign exchange reserves. The Egyptian pound depreciated by more than 5 per cent in the following two weeks.

The IMF announced on 20 November that it had reached a staff level agreement with the government for a $4.8bn standby credit facility, which was part of an overall package of $14.5bn in donor funding and deposits.

The main focus of the programme that was initially agreed with the IMF was the budget deficit. However, the IMF was not pressing for immediate austerity measures. A senior official in the Finance Ministry told MEED that one of the IMF’s requirements was that the government should revise the budget for the current fiscal year (1 July 2012-30 June 2013) to show a higher deficit than the one in the original budget.

Any further delays in concluding the IMF agreement would be likely to provoke a flight of Egyptian capital

The government had approved a budget showing the deficit coming down to 7.6 per cent of GDP in 2012/13 from 10.9 per cent in 2011/12, but this depended on unrealistic assumptions both of revenue increases and of cuts in spending on energy subsidies. By the end of November (the fifth month of the fiscal year), the deficit was already 4.5 per cent of projected GDP for the full year, indicating that there was little chance of meeting the original target. The IMF had specified that it supported the aim of bringing the deficit down to 8.5 per cent of GDP in 2013/14, implying that it was ready to accept a deficit of about 10 per cent in 2012/13.

In order to achieve the medium-term targets agreed with the IMF, the government would need to start introducing some revenue-raising measures and spending adjustments.

Tax increases in Egypt

The government subsequently announced some increases to fuel prices, starting with high-octane petrol. In early December, it published a set of increases to duties on a wide range of items, including beer and cigarettes. It also said that it would start to levy a long-delayed property tax – a flat-rate 10 per cent of rentable value on properties worth more than £E2bn ($307,000) – from 1 July.

However, the tax increases were immediately criticised by Mursi’s Freedom & Justice Party (FJP). Mindful of the referendum on the constitution and the forthcoming parliamentary election, Mursi responded by cancelling the tax increases. The government also asked the IMF to call off a meeting scheduled for 19 December to approve the standby credit.

Mursi registered his dissatisfaction with the Finance Ministry for pushing through the tax increases by dismissing the minister, Momtaz el-Saeed, in a reshuffle at the start of January. His replacement is El-Morsi el-Sayed Hegazi, a university professor. Hegazi does not have any known affiliation to the Muslim Brotherhood, but several others among the 10 newcomers to the cabinet have a background in the Islamist movement. He has stated his support for swiftly concluding a deal with the IMF, but given his lack of direct experience of economic policymaking, this will be hard to achieve unless he delegates full authority to the ministry team that has been conducting the talks with the IMF.

The fund’s negotiators will also be dealing with a new governor of the central bank. However, this should not pose any serious problems as Hisham Ramez, whose appointment was announced on 10 January, is a familiar face, having been deputy governor during the first round of talks with the IMF in 2011. He left the central bank in September that year to become a managing director of Commercial International Bank (CIB), one of Egypt’s largest private banks.

The first indications that Ramez had got the governor’s job came on 22 December, when state media reported that he had been chosen to replace Farouk el-Okdah, who had supposedly resigned. El-Okdah had earlier indicated that he wished to step down at the end of the year, as he had already exceeded the two-term limit specified in the constitution. However, the resignation story was denied, and El-Okdah stayed on to supervise the introduction of the foreign exchange auction system and to manage the reaction of the market. Ramez will formally take over on 2 February. His first term will run until November 2015, which will mark four years from the end of El-Okdah’s second term.

New governor

Ramez was the public face of the central bank in the turbulent period after the overthrow of Hosni Mubarak. He was also involved in dealing with the impact of the global financial crisis on Egypt in 2008. While he was still with CIB, Ramez said that Egypt’s relations with international financial investors had been severely tested on both occasions, but had survived intact.

He said that in 2008, foreign investors had withdrawn $16bn from Egypt, without penalty, and that much of this had come back the following year. In the wake of the 2011 revolution, there was an outflow of $12bn, again without the investors facing difficulties in withdrawing their funds. “The financial markets tested us in extreme circumstances,” Ramez said. “But they got their money out, and that will always be the case.”

Egypt’s track record of enabling financial investors to pull out should provide an incentive for these investors to return once confidence in the country’s economic prospects has been rebuilt. The IMF agreement is supposed to be an essential element in restoring that confidence. Investors have also been waiting to see the extent of any devaluation of the Egyptian pound.

The decision of the central bank to allow the local currency to depreciate at the start of 2013, after holding the pound steady for most of 2012, could eventually provide some encouragement for foreign investors. However, the circumstances of the shift in policy mean that investors are likely to remain cautious for some time to come. It is not clear whether the central bank acted according to a set plan, perhaps agreed with the IMF, or whether it was reacting to signals from the market that demand for foreign currency was not being satisfied by the banking system.

 Over the previous two to three months, a parallel exchange rate had re-emerged for the first time since 2003-04. Another key question was whether the move was related to the change at the top of the central bank. Had Ramez set a condition that the devaluation start before he took the helm? Investors will also want to be sure that the IMF agreement is back on track before they commit fresh funds to Egypt.

Qatar support for Egypt

In the meantime, the central bank’s net international reserves are being propped up by infusions of funds from Qatar. Reserves have stabilised over the past 12 months at about $15bn, which is sufficient to cover only four months of imports. Qatar has provided a $500m grant and injected a further $2bn in deposits. The Qatari prime minister, Sheikh Hamad bin Jassim al-Thani, said during a visit to Cairo on 9 January, that the grant would be increased to $1bn by moving $500m from the amount already deposited with the central bank, and that Qatar will provide additional deposits of $2bn.

This will help to tide Egypt over for the next couple of months, including a payment of about $750m due to the Paris Club of international creditors in January as part of a 1991 debt restructuring deal. However, Qatar cannot be expected to bankroll Cairo indefinitely. The government seems to believe that it can soften the edges of the IMF programme, but this could be a risky approach.

Any further delays in concluding the IMF agreement would likely provoke a flight of Egyptian capital, which would only accelerate the decline in the value of the currency. A managed devaluation of 5-10 per cent would have some limited inflationary impact, but would benefit exporters and potentially attract investors. A runaway devaluation would make inflation much worse and undermine the positive effects of the adjustment.