THE Egyptian government is basking in the unfamiliar glow of approval from the international financial community for its economic reforms.

The World Bank has endorsed the steps taken to restructure the public sector and privatise state-owned assets, and the IMF says Egypt is substantially on target in its monetary and fiscal policies. These votes of confidence should be sufficient to allow the third and final tranche of a $10,000 million Paris Club debt relief package signed in 1991 to go through in July.

But the success in stabilising the economy through tight fiscal and monetary policies is only part of the long-range effort to tackle structural weaknesses and allow Egypt to achieve the strong growth rates vital to increase employment and raise living standards.

Crucial issue

Without a significant rise in private investment and more progress in the slow-moving privatisation programme, the goal of higher growth will be difficult to attain. The crucial issue, in the view of many Cairo business people, is to provide sufficient new investment channels before the huge liquidity surplus in the banking system starts to endanger the whole reform process.

The positive indicators the government can cite as proof of its success include the reduction in the budget deficit for fiscal year 1993/94, which ends on 30 June, to just 2.5 per cent of gross domestic product (GDP). That has helped bring inflation down. Consumer prices in February 1994 were 7.3 per cent higher than in February 1993. The average inflation rate over that 12-month period was 11.3 per cent.

The government has announced a modestly expansionary budget for 1994/95, with spending set to increase by about 7.5 per cent, roughly in line with inflation. Business people say they hope any spending increase will be effectively used, along with the $600 million Social Fund, to improve the living standards of the poor.

‘The benefits of the reform process have not trickled down to the average Egyptian,’ says Omar Mahanna, corporate finance chief of Misr Iran Development Bank, and an active member of the liberal political grouping New Civic Forum. Only by directing extra spending towards social services and job creation will these benefits be felt by the majority of the population, he says.

The hard years of reform have taken their toll, as poorer Egyptian households have had to pay ever-increasing bills for their electricity, water, food and clothing while wage increases have lagged behind inflation and unemployment has risen inexorably.

The widespread perception of falling living standards is borne out by the macroeconomic data. Real economic growth has been lower than 1 per cent for the past three years, while the population has increased at an annual rate of over 2 per cent. The government predicts economic growth will rise to about 2 per cent in 1993/94, and to 3-4 per cent the following year. Significantly higher growth rates in subsequent years will be needed to induce any general sense of prosperity.

The chief concern of Cairo business people as the economy starts to shift into a stronger growth phase is the enormous surplus of liquidity that has built up in the banking system. There are fears that this surplus, put at about £E 4,400 million could drive interest rates down to the point where the flow of funds into Egyptian pounds is rapidly reversed. This would put heavy pressure on the local currency and test the resolve of the Central Bank of Egypt.

The liquidity has built up over the past two years because of the strong movement of funds into Egyptian pounds, attracted by a large interest rate differential in favour of the local currency. The reference points for interest rates have been the regular auctions of six-month treasury bills. Rates on the bills have come down close to 13 per cent, from a high of 19 per cent, as the central bank has reduced the frequency of its issues. With US interest rates starting to edge upwards, the differential in favour of the Egyptian pound is steadily being eroded.

An added worry for bankers is the apparent commitment of the government to maintaining the stability of the Egyptian pound, which has only lost a fraction of its value against the dollar in the past three years.

The importance of exchange rate stability is often overstated, according to Rafiq Sowellam, head of foreign exchange operations at the Economy Ministry. ‘People emphasise stability as a sign of success – as a professional economist, I challenge this,’ says Sowellam. This view is echoed by bankers who say they believe the Egyptian pound is being kept artificially strong for political rather than strictly economic reasons.

Flight of funds

The fear expressed by some bankers is that a failure to address the liquidity issue will result in a flight of funds out of Egyptian pounds into dollars. ‘If the exchange rate begins to nose-dive, the central bank’s $16 billion reserves could be used up very quickly,’ says the manager of one joint- venture bank.

The key to absorbing the excess liquidity in the banking system will be to bring on to the market new financial instruments, in particular long-term treasury bonds, corporate bonds and shares in privatised companies, bought directly or through participation in investment funds. The stirrings of life in the securities market suggest that a solution to the liquidity problem may be at hand.