Egypt’s economy is experiencing con-tradictory performance. On the one hand, Cairo’s much-vaunted economic reform programme continues to deliver striking results. According to the government, the country is expected to enjoy growth in gross domestic product (GDP) of 7.2 per cent for the financial year 2008/09, which starts on 1 July, improving on the already impressive 7.1 per cent GDP growth expected for the current financial year.

Consumer spending and investment are both showing an upward trend, unemployment fell from 11.8 per cent to 9 per cent between the end of 2004 and March 2007 and, according to the World Bank, Egypt was the fastest-improving economy for investment in the world in 2007.

But it is a different story on the streets. Local people are forced to wait in line for several hours to buy that most basic of staples, bread. Up to 15 people are reported to have died in the queues, either from violence or heat-induced health problems. Army bakeries have had to be opened to deal with the crisis. Doctors, academics and textile workers have all gone on strike in recent weeks demanding higher wages, and political opposition groups organised a national ‘day of anger’ - the first of its kind - on 6 April.

Deficit reduction

The fundamental problem for the government is that to encourage long-term growth and create sustainable employment, it needs to reduce its fiscal deficit. The government’s objective is to reduce its deficit to 3 per cent of GDP by 2010/11, from 6.9 per cent in 2007/08. To do this, it needs to reduce its expenditure, and the obvious way to do that is to cut the bill for wages and subsidies.

But while Cairo has had some success in reducing energy subsidies, cutting food subsidies is a much more delicate matter. When former President Anwar Sadat attempted to raise food prices in 1977, the resulting riots led to the deaths of at least 70 people.

To an extent, the country has been a victim of the increasing price of grain on the world market, the effects of which have by no means been confined to Egypt. On 13 February, the UN’s Food & Agriculture Organisation announced that high food prices had left 36 countries in need of external assistance.

“Massive rises in staple prices are affecting everyone in the region,” says George Joffe, director of the Centre for North African Studies at Cambridge University in the UK. “It is part of a general problem.”

Egypt is the world’s largest wheat importer, with annual imports of about 7.5 million tonnes, making it especially vulnerable to grain price increases. Between February 2007 and February 2008, the price of unsubsidised bread in Egypt increased by 26.5 per cent, according to government figures.

Table: Financial indicators

GDP=gross domestic product; na=not available. Source: International Monetary Fund; Finance Ministry

Managing reform

But while Cairo can be partly exonerated for the food price crisis, it still has to bear the consequences. The government is facing the unenviable problem that the long-term demands of its reform programme and the short-term needs of its people are pulling it in opposite directions.

In the short term, the administration has introduced a series of economic measures to alleviate the food crisis. In late March, it announced the cessation of rice exports between April and September, and on 2 April it lifted import duties on basic foods including rice, dairy products, cooking oil and powdered baby milk.

Government officials have promised to build thousands of new bakeries to address the bread shortage, with bread production in the province of Alexandria set to increase by 40 per cent to 14 million loaves a day.

It has also decided to sacrifice an immediate reduction in the budget deficit in favour of supporting the poor. According to the latest World Bank statistics, about 40 per cent of Egypt’s population live on less than $2 a day.

The draft budget for 2008/09 includes a 15 per cent wage increase for the 5.7 million workers employed by the government, and a 110 per cent increase in food subsidies to £E20bn ($3.6bn).

The wage increase builds on similar measures introduced since 2005/06 that have together increased the starting salary for a graduate joining government service by 70 per cent, according to the Finance Ministry. The increase in food subsidies follows an emergency measure in late 2007 to increase planned expenditure to £E15bn from the £E9.5bn budgeted at the start of the financial year.

Wages are also being increased for specific groups. In the forthcoming financial year, the government will spend £E3.1bn on increasing the wages of teachers, doctors and university professors.

Wage rises

The increase in pay for school teachers is the second phase in a scheme that raised their salaries by 50 per cent in 2007/08.

Overall government expenditure on wages and salaries for 2008/09 is anticipated to be 7.3 per cent of GDP. In terms of fiscal discipline, while this is a marked improvement on the 8.1 per cent of GDP in 2002/03, it represents an increase from the 7.1 per cent spent over the past two years.

“It is important for the government’s social agenda,” says Hany Kadry Dimian, deputy finance minister and head of the micro and fiscal unit at the Finance Ministry.

But what of the reform programme? The draft budget provides for the budget deficit as a proportion of GDP to remain at 6.9 per cent in 2008/09, the same as in the previous financial year, thereby breaking the downward trend established in recent years.

The Finance Ministry insists that its stated aim of reducing the deficit by 1 per cent a year is an average rather than a yearly obligation, and that other measures, such as the reform of the VAT system planned for 2009/10, will redress the balance.

But the degree to which Cairo has had to increase expenditure on subsidies and wages was clearly not part of the plan when the cabinet first sat down to discuss its strategy for reducing the fiscal deficit following the 2004 elections. There is hope, though, that the circle can be squared.

That food subsidies will be retained is a given, and in the current climate it is unlikely that the government will have much scope to reduce them. On the contrary, it is planning to increase the coverage of the subsidies to a further 10-15 million people.

However, their efficiency can be improved. The administration admits that while inter-national grain prices played a significant part in the recent bread crisis, the inefficiencies of the distribution system, which allowed for a substantial amount of subsidised flour to be diverted onto the black market, were equally to blame. The government estimates that at the current rate, the black market for flour is costing the administration £E5bn a year.

Table: Egyptian Budget (selected items)

*increased to £E15bn in late 2007. GDP=gross domestic product. Source: Finance Ministry

Targeted subsidies

The breakdown of the bread subsidy system illustrates a wider problem of poorly targeted fuel and food subsidies.

“Inefficient and poorly targeted fuel and in-kind food subsidies provide significant scope to secure savings for fiscal consolidation,” said the International Monetary Fund (IMF) in its most recent Article IV report, published in December.

“Spending in these two areas is large relative to countries of similar income levels. The
effective resource transfer to the poor provided by food and energy subsidies is limited and highly expensive.”

Progress has been made to improve the targeting of fuel price support. Subsidies for high-octane petrol have been cut, while those for the lower-grade fuels consumed by poorer members of the population remain in place. But the food subsidies system is in disarray, with entitlement to the ration cards on which the allocation of many subsidised products is based increasingly outdated.

Linking systems

Here again, the government is taking steps to address the issue. “We carried out a pilot to automate the ration card system in Suez and the results are good,” says Dimian.

“The next step is to link the system with data held by the Finance Ministry to establish who is really eligible for subsidies. We also plan to put a stop to the smuggling of flour. The reforms are not easy but they are happening. They are crucial to improving the social safety net.”

The government is also increasing investment in the health and education sectors in an effort to improve the standard of living of the general population. The draft budget for 2008/09 proposes a 13 per cent increase in education spending to £E35bn and a 4 per cent increase in expenditure on health to £E12.3bn. But again, the government must ensure the efficient targeting of these funds.

“In the past - everyone was being trained for everything, but really they were being trained for nothing,” Investment Minister Mahmoud Mohieldin told an investors’ conference in London in late March. “Unless we improve education, we will not achieve anything. We are improving access to all of the regions so as not to concentrate growth in Alexandria, Giza and Cairo. We are also improving gender access.”

If the efficiency of the government’s social spending can be improved, it will have two benefits: it will address the poverty issue by directing funds to those members of the population that most need them; and it will help to control the growth in the government’s spending, enabling it to put its plans to reduce the budget deficit back on track. Then, perhaps, Egypt’s economy will no longer be such a contradiction.

Key fact

The price of unsibsidised bread in Eqypt increased by 26.5 per cent between February 2007 and February 2008