EGYPT’S budget deficit is comfortably below 3 per cent of gross domestic product (GDP) and inflation has dipped below 10 per cent, foreign exchange reserves are sufficient to finance 18 months of imports with ease and the balance of payments is in surplus for the third year running. So why are the IMF and the World Bank unwilling to give Egypt’s economic programme a clean bill of health?

The answer is partly to do with the Washington institutions’ views on what should happen next – in essence devaluation, more privatisation and deregulation – and partly related to the government’s feeling that, with foreign exchange reserves of more than $17,000 million, it is immune to IMF/World Bank pressures.

The IMF has argued strenuously that growth of investment and exports are being held back by the government’s insistence on maintaining an overvalued exchange rate and, by association, high interest rates. The fund and the bank have also made clear their view that the government is dragging its feet on privatisation.

However, the only real pressure the IMF can exert at the moment is withholding its approval for the third and final tranche of Paris Club debt relief. This tranche involves payments of some $4,000 million to 17 OECD creditors. The pressure is not particularly hard, as Egypt is quite capable of meeting these debt repayments and its other obligations. It is also finding that Western export credit agencies are becoming more friendly, resuming cover and cutting premiums in recognition of the country’s sound economic fundamentals.

The basic economic data is indeed reassuring in comparison with the situation 10 years ago. Then, debts were not being serviced, the currency was in free fall, and import cover was to be measured in weeks. But Egypt does still face some tough challenges if it is to make the transition from an economy that has managed to stave off catastrophe to one which is capable of spreading the benefits of prosperity to its long-suffering population.

AID: Egypt has had privileged access to Western, multilateral and Arab aid over the past 20 years. It has been used to rebuild neglected infrastructure, giving Egypt much improved water and sewage systems, sufficient power supplies, and adequate transport and telecommunications networks. The aid has also helped develop agriculture, to the extent that Egypt can be confident of meeting its food needs through domestic production and sustainable imports well into the next century. Finally, the US component of the aid has helped Egypt re-equip its armed forces with modern Western weaponry.

Now the picture is changing. US diplomats say they expect American civilian and military aid, totalling $2,115 million a year, to be phased out over the next three years. This will have a particularly marked impact on the armed forces, which have received $1,300 million in military grants from the US since 1984. The loss of US civilian aid can be partly compensated for by increased European aid. The EU is considering a package of some $6,000 million in aid to Mediterranean countries that will include Egypt. France, Japan, Germany and Denmark also maintain active aid programmes, the latter two focused particularly on environmental projects.

But Egypt is having to adapt to much lower total levels of aid. This means that borrowing from local banks is becoming a more common form of project finance, as with the second line of the Cairo metro, and privatisation of utilities is on the agenda. Electricity & Energy Minister Maher Abaza says the eight power distribution companies will be privatised once a regulatory agency has been established, and work is to start this year on drawing up the terms of reference for Egypt’s first build-operate power stations.

In the power sector, as with water, wastewater and telecommunications, the government has already been obliged to cut subsidies and improve administrative efficiency as a price for previous aid support. The intention has always been to make these sectors self-reliant, and the reduction in aid in the future will put that policy to the test.

FINANCIAL POLICY: In June 1991, the proportion of bank deposits held in Egyptian pounds exceeded those held in foreign currencies for the first time in decades. The flow of funds into local currency deposits resulted mainly from the high level of domestic interest rates, and helped the government sustain its policy of maintaining a stable exchange rate. Interest rates started to come down during 1994, and by the end of the year, the interbank rate had fallen to 11 per cent. It is now 14 per cent, and a number of banks report that dollar deposits are starting to exceed holdings of Egyptian pounds.

According to Central Bank of Egypt vice-governor Mohamed el-Barbari, the rise in interbank rates was a response to the pricing of the government’s first long-term treasury bond issue, involving £E 3,000 million of five- year paper paying 12 per cent a year. He says banks with excess liquidity had been prepared to lend at below the short-term treasury bill rate of about 10.5 per cent, but have raised rates now that the bond has mopped up much of that liquidity.

El-Barbari says it is logical that banks which invested in the bonds should raise their deposit rates to attract fresh funds to replenish their liquidity. The main buyers of the bond were commercial banks, mutual funds, insurance companies and public sector companies, which received £E 1,600 million in total. The four public sector banks together bid for the entire £E 3,000 million, but were allocated £E 1,300 million. The remaining £E 100 million went to individual investors.

Egyptian American Bank general manager Gary Jones says the bond provided an attractive return in light of the tax advantages. Banks pay tax on interest they receive from loans, but the returns on the bonds are tax exempt. ‘If you build in the tax element, the bonds will yield about 17 per cent,’ he says.

That opinion is not shared by another senior banker, Commercial International Bank (Egypt – CIB) general manager and board member Adel el-Labban. CIB did not buy into the bond, he says, because it considers the inflation outlook to be higher than 12 per cent over the five-year life of the paper. He says he believes the rise in interest rates after the bond issue was part of a government policy to try to stem the drift of deposits back to dollars, not just a reaction of the market to the liquidity squeeze.

The policy of maintaining an effective dollar/Egyptian pound parity puts Egypt in the Argentine school of development economics, at least in monetary policy. This is a deliberate choice on the part of International Co-operation Minister Youssef Boutros Ghali, the government’s front man in negotiations with the IMF. The contrasting experiences of Mexican devaluation and Argentine dollar/peso parity are constantly evoked in defence of Egypt’s policy. However, the government still lags far behind its Latin American model in its achievements in structural reform.

The process of overhauling the public sector is at an early stage, and the government has not yet addressed the problem of what to do with the worst-performing companies. Privatisation has so far been restricted to relatively healthy firms. Trade liberalisation has made some progress, with a gradual reduction and simplification of tariffs, but exporters in particular still face bureaucratic obstacles.

The next major legislative step is to be the enactment of a new company law that would replace the three main laws now in operation. At present, private investors have the option of investment law 230, which offers free capital repatriation and tax holidays but requires Investment Authority approval, or law 159, which requires simple company registration but does not provide for capital repatriation. The other main company law is 203, covering the public sector. The new law, a draft of which is now being circulated to business associations, proposes tax incentives based on geographical location and type of project. It will eliminate the distinction between companies, and allow for a transitional phase for public sector companies to be transformed into entirely private entities. The Investment Authority would change into a registration office.