Four years on from the January 2011 revolution and Cairo is working hard to resurrect Egypt’s economy from the mire of political instability, deteriorating investor confidence and social unrest.

We are creating a new framework for the private sector to take a leading role in driving economic growth

Hanan Salem, Ministry of Finance

In October 2014, under the new government headed by President Abdul Fattah al-Sisi, the Finance Ministry unveiled a five-year plan to do just that. The policy framework targets real GDP growth of 6 per cent by 2018/19, as well as the reduction of the fiscal deficit, more jobs and increased investment in the country.

“The key message is that through fiscal consolidation and prudent monetary policy, as well as legal and regulatory reforms, steps are being taken to improve the country’s investment climate,” Hanan Salem, first deputy minister for economic and financial policies at the ministry, tells MEED.

Private investors

“We are creating a new framework for the private sector to take a leading role in driving economic growth,” adds Salem. She says private investors need to be the driving force in generating economic growth and helping ease the financial burden on the government’s strained finances.

A coherent plan to overhaul Egypt’s economy and restore investor confidence in the country is much needed.

Since the end of President Hosni Mubarak’s almost 30-year reign in 2011, the Egyptian economy has spiralled into decline. GDP growth fell from 5.1 per cent in full year 2010 to just over 2 per cent in 2013 and 2014.

Under the subsequent rule of the army followed by Muslim Brotherhood-backed President Mohamed Mursi between 2012 and 2013, the government’s finances remained in a state of disarray, with the budget deficit standing at 12.6 per cent of GDP in the financial year 2013/14. Government debt has risen to 97 per cent of GDP.

Reducing deficit

The new five-year plan aims to reduce the fiscal deficit to 8-9 per cent of GDP and decrease government debt to a range of 80-85 per cent of GDP. In the near term, the ministry is aiming to bring the deficit down to close to 10 per cent in the financial year 2014/15.

Salem says the Ministry of Finance is tackling the country’s finances by both cutting expenditure and increasing sources of revenue for the government.

On the expenditure side, the biggest development to date has been the cut in energy subsidies. In July, the government raised the price of some fuels by as much as 80 per cent.

The cuts represent about 2 per cent of Egypt’s GDP and already public spending on subsidies has significantly fallen, dropping to £E22bn ($3.1bn), a 29 per cent decline, in the first quarter of the fiscal year 2014/15. This compares with a total of £E31bn spent during the same period last fiscal year. “This was a very significant and bold move that provided a strong demonstration of the government’s commitment to ensuring the budget is put onto a more sustainable track,” says Salem.

There will be further cuts in energy subsidies, but the next one will be not as large as the first cut. “We are looking at a 1 per cent GDP adjustment each year over the medium-term horizon and this will be done through a variety of ways, not just via price moves but also by controlling quantities using the new smart card system and by diversifying the energy mix,” says Salem.
A pilot smart card system has already been put in place in Port Said, and will be launched nationwide in April 2015. The scheme is designed to first gather data on fuel consumption patterns, which will pave the way for the government to then potentially introduce quota allocations.

Wage bill

Salem says the system will also help tackle problems such as fuel smuggling by more effectively tracking the energy supply chain.

Reducing the country’s public sector wage bill is another major challenge facing the government. A new law governing wages is currently being drafted by the Ministry of Planning. There has already been some backlash to the concept of putting caps on wages in the public sector, with many saying it will lead to a “brain drain” of top talent from public sector entities such as state banks.

However, Salem counters this by saying it is important to enhance the appeal of the private sector as well as create opportunities within both the public and private sectors for well-educated young people to rise up through the ranks.

On the revenue side, the government is implementing reforms in order to broaden the country’s tax base. A new property tax is currently being implemented and is expected to generate 0.4 per cent of GDP in 2014/15.

VAT law

Cairo is also aiming to introduce a new value-added tax (VAT) law in the second half of the financial year 2014/15, which will replace the previous goods and services tax system. The new tax is expected to yield 1.6 per cent of GDP a year. Salem says internal preparations have taken place and the Ministry of Finance is currently engaging with the Egyptian population and businesses. “It is not easy, but we have already gone through these types of discussions when implementing the property tax,” she says.

“This required dialogue with the public and the effort is still ongoing. But the story with the property tax is another very good indicator of the government’s commitment to move forward with reforms in order to consolidate its budget deficit.”

Other planned tax reforms include a hike in excise taxes on cigarettes and alcoholic drinks. Salem is all too aware many of the planned measures are unlikely to be popular with many sectors of the Egyptian population. The first subsidy cuts saw some people take to the streets to protest against the rise in their fuel costs.

As the government mends its finances, Egypt also needs to look after the welfare of its people, particularly in a country with high poverty rates. Maintaining social stability is a key factor in improving the investment environment.

“The fiscal consolidation measures are being balanced with measures to ensure the poorest and most vulnerable segments of society are protected as we go through this transition,” says Salem.

Helping the poor

In the case of the subsidy reform, certain people will be compensated for the cuts through an expanded cash transfer programme. Similarly, the new property tax is not aimed at the poorest sections of society, with those whose first home is under £E2m exempt from the tax.

Meeting the target over the next five years will require the persistent implementation of the reform measures

Hanan Salem, Ministry of Finance

Furthermore, 50 per cent of the proceeds of the tax are earmarked to go towards rural development and to improve conditions within informal settlements.

These measures are designed to improve long-term social and economic stability even if they slow down efforts to reduce the government deficit in the short term. “The pace of fiscal consolidation would be considerably faster if it were not for these offsetting measures,” says Salem.

Additional measures to improve social conditions include the constitutional mandate to increase spending on health, education and research and development to 3, 6 and 1 per cent of GDP respectively.

“These are actually very important areas of expenditure,” says Salem. “Fulfilling the constitutional spending mandate will help make our large labour force, which is one of Egypt’s strengths, healthier and better educated.

Moreover, the shift from wasteful and regressive spending such as on energy subsidies to these more productive areas will help improve the structure of the government’s budget.”
Egypt is also looking to attract investment into the country’s renewables sector as a means of lessening its dependence on energy imports, tackling energy shortages, driving economic growth and creating jobs.

Renewables drive

The government is aiming to have renewable sources of energy such as wind and solar make up 20 per cent of the country’s energy mix by 2020. It is looking to implement a 4,300MW wind and solar programme in the coming years. Cairo established feed-in tariffs in September, and received expressions of interest from developers in November for several projects.

Contracts are expected to be awarded by late 2016 and the planned independent power projects (IPPs) will connect to the grid under the feed-in tariff system, with 25-year contracts for solar projects and 20-year deals for wind farms.

Private investment will be key in developing these schemes, and the government’s private-public partnership (PPP) unit could help support such investment. To date, there have been limited PPP projects completed in Egypt, but the PPP unit is already looking to tender at least 19 projects in the coming years, some of which will be in the energy sector.

“Rather than having the budget directly bearing the burden, you have a PPP programme to ensure the projects are commercially viable and feasible, and will deliver a high quality of service,” says Salem.

Right path

In terms of macroeconomic and fiscal indicators, Egypt appears to be on the right path to hit the targets set out in its five-year plan.

Provisional figures for the first quarter of 2014/15 suggest economic growth was 6.8 per cent, compared with the same quarter last year. The final quarter of 2013/14 recorded growth of 3.7 per cent.

Although these high rates of growth are due in part to the very low levels seen in 2013, it is also an indication the economy might be turning a corner, says Salem. She notes that the manufacturing sector is experiencing a rebound, while tourists are also returning to the country. In September, tourist numbers increased by 193 per cent to 884,000, compared with 301,000 tourists in the same month last year.

Full speed ahead

Cairo has adopted a conservative approach to the underlying assumptions that have shaped the five-year targets, says Salem.

The framework policy was based on oil being at $105 a barrel. With global prices plummeting, Egypt, as a net importer of fuel, could see beneficial effects of the decline on its budget. The five-year plan is also based on GDP growth hitting 3.5 per cent this year, but Salem forecasts that the rate could easily reach 4 per cent.

But Egypt must keep its foot on the pedal if it is to achieve its aims and build a more enticing investor environment.

“Meeting the target over the next five years will require the persistent implementation of the reform measures,” says Salem.