The billions of dollars in aid provided to Cairo by Gulf countries since President Mohamed Mursi was ousted from power in July last year have been critical in preventing Egypt’s economy from collapsing.

But with Egyptians preparing to vote for yet another president, the government needs to think about how to reform the economy to generate long-term growth, rather than becoming reliant on donor aid and bilateral loans.

Reform will also open up the possibility of tapping other avenues of funding, from multilateral financial institutions such as the Washington-headquartered IMF, as well as attracting foreign investors back to the country.

Weaning itself off regional aid, however, will require Cairo to implement difficult reforms such as energy subsidy reduction while avoiding creating further social unrest.

Troubled economy

The current interim government inherited a troubled economy from the Mursi administration. Egypt has a huge deficit running at about 12 per cent of its GDP. Its currency had been depreciating and the cost of importing food and fuel was rising rapidly. The tourism industry, a central cog of the country’s economy, was still recovering from the slump that followed the 2011 revolution.

By June 2013, Egypt’s foreign exchange reserves stood at $14.9bn, just enough to cover 3.1 months of imports and 57 per cent lower than the $35.2bn the country had in June 2010. 

Saudi Arabia, the UAE and Kuwait came to the rescue of the temporary government installed in July last year, pledging $12bn in loans, aid and grants. Pleased to see the end of a Muslim Brotherhood-backed government, the Gulf countries were keen to use their wealth to bring about economic and political stability.

By the end of December, deposits and grants from the Gulf totalled $10.8bn. A total of $6bn was provided in the form of central bank deposits. The UAE provided a further $1bn fiscal grant and all three provided a total of $3.4bn to finance petroleum imports.

“The GCC support is the main reason why we raised the rating to B- from CCC+ and revised the outlook to stable,” says Trevor Cullinan, the Dubai-based director of sovereign ratings at US ratings agency Standard & Poor’s, referring to its upgrade made earlier this year.

The deposits increased net international reserves at the central bank, which rose to $17bn-$18bn over the course of the year.

The aid also helped Cairo repay $3bn in higher-cost loans and deposits to Doha. Qatar had stepped in to fund Egypt following the overthrow of Hosni Mubarak in 2011 and had supported the Mursi-led regime. 

The improved supply of foreign exchange enabled the government to tackle the $6.3bn-worth of outstanding payments owed by the Egyptian General Petroleum Corporation (EGPC) to energy companies. EGPC paid $1.3bn in December and will pay $3bn in monthly instalments until 2017. 

Business confidence has further recovered with the Egyptian stock market rallying by more than 70 per cent since July 2013. The stock market is expecting to welcome its first initial public offering since 2011, with Arabian Cement Company planning to list at the end of May.

The UAE made a further concession loan (one that bears no interest), which forms the bulk of Egypt’s second £E33.9bn ($4.9bn) stimulus package announced in February. The spending targets infrastructure investment and social programmes, such as public sector wage increases. 

No solution

There has also been indirect support from the UAE, with companies based in the emirates making investments in Egypt. In March, UAE construction and real estate company Arabtec Holdingsigned a $40bn deal with Egypt to build 1 million low-cost homes. Dubai-headquartered retail developer Majid Al-Futtaim also plans to build at least four new malls in the country.

Although the Gulf funding has been essential to prop up the economy; it is far from the panacea to Egypt’s financial problems. Despite the various stimulus packages, tourism receipts are still low, the deficit remains high, and unemployment has crept back up. 

“The key view is that GCC support is positive as it helped to bridge Egypt’s funding gap, but it is not a solution to the country’s underlying issues regarding its unsettled political situation,” says Steffen Dyck, assistant vice-president, sovereign risk group, at the US’ Moody’s Investor Services.

Egypt is preparing to vote for a new president in May. It is anticipated that once a new leader is in place (most likely the former army chief, Abdul Fattah al-Sisi), he will usher in era of relative political stability, enabling the government to start tackling the country’s underlying problems.

“It is really more about delivering tangible progress on reforms such as property tax, subsidies and income tax,” Dyck says.

Many analysts see a continued over-reliance on GCC support as a risky scenario. “Over the long term, there are certainly some issues regarding reliance on bilateral funding as it is not clear how much funding will be provided by the GCC in the future. Although the three Gulf countries are wealthy and have high ratings, their pockets are not limitless,” Cullinan says.

For external investors looking at Egypt, the lack of information means there is little clarity as to what extent the country can rely on the funding and also what conditions are tied to the bilateral loans.

There is limited concern about Egypt racking up high levels of external debt through securing GCC aid. External debt has jumped from 14.8 per cent of GDP in 2010/11 to 18.5 per cent of GDP in 2014/15, but much of this debt comprises interest-free Gulf loans.

Egypt has also met its repayment deadlines for the money it borrowed from Qatar under the Mursi government.

To-date, Cairo has returned a $2bn deposit to Qatar after talks to convert it to a bond failed. At the end of 2013, it returned two $500m tranches. This leaves $3.5bn of Qatari aid outstanding, with $3bn due to be repaid by the end of 2014.

The biggest economic problem Egypt faces is its fiscal deficit and high volume of domestic debt. The country’s deficit rose 44 per cent to reach the equivalent of $37.2bn in 2013. The financing required to support this has pushed up government debt from 76.6 per cent of GDP in 2010/11 to an anticipated 92.7 per cent in 2014/15, according to IMF projections.

Much of Egypt’s deficit is financed through domestic bank borrowings, since the country’s low credit rating makes it hard to raise money internationally. In 2010, the domestic banking sector financed 40 per cent of the fiscal deficit. This proportion leapt to 92.3 per cent by the end of 2013.

Cairo needs to reduce spending and increase its sources of revenue to tackle this mounting debt burden. It can do this by reducing government subsidies for energy and food, as well as investing in new infrastructure.

If tackled successfully, Egypt will be in a better position to win financial support from multilaterals such as the IMF. The fund only lends to countries that fulfil a specific list of reforms.

Yet these reforms are unpopular with large sections of society and, if managed badly, could sow the seeds for yet another revolution.

“Any restructuring programme will be tough. No one wants to wake up and know there are fewer subsidies and less electricity, or food prices are going up, but the government no longer has the means to finance these subsidies,” says Wael Ziada, head of research at Egyptian investment bank EFG Hermes.

Options for reform

There are signs that reform is moving up the agenda, with the government resuming contact with the IMF, after talks regarding a potential $4.8bn deal collapsed during the Mursi administration in late 2012.

Several missions from the fund have since visited Egypt to advise on the introduction of value-added tax (VAT). VAT is likely to be a requirement of any future IMF funding.

However, most analysts think an IMF package is unlikely in the near-term, particularly due to the political sensitivities surrounding multilateral aid. “If Egypt carries out economic restructuring in conjunction with the IMF, what you are telling the world is that you are making the reforms to secure IMF money. This won’t please large segments of the population, who see the IMF as a US-backed entity and see IMF funding as political money,” says Ziada.

Reducing the large deficit independently before starting IMF negotiations may be a better option for Egypt. There is also no urgency yet to win the funding, given the amount of aid coming in from the Gulf and which will continue to keep the country afloat in the short term.

Cairo would be wise to make use of the breathing space the Gulf money has afforded it and think carefully about how to implement much-needed structural reforms in a way that improves the economy, but does not widen the already entrenched rifts in Egyptian society.