Wednesday, 17 July 2013

Why Egypt may eventually need a larger IMF loan

Despite the recent support from the Gulf, Egypt's reserves remain below safety levels.

One of the first things the new political order in Egypt did was to dispatch Hisham Ramiz, the governor of the Central Bank of Egypt, on a fund-raising trip to the United Arab Emirates. His visit was evidently fruitful as it resulted in an aid package consisting of grants, loans and energy products worth $12 billion not just from the UAE but also from Saudi Arabia and Kuwait.

Some of these loans will enter as deposits at the central bank, boosting the headline figure for international reserves, which took a hit in June largely due to the fall in gold prices. The significant inflow of funds from the Gulf notwithstanding, it remains unclear whether Egypt's reserves are sufficient for the economic needs of the country and an analytical framework to assess that question is needed.

Reserves act as a precautionary tool to absorb shocks to the economy and ensure the availability of sufficient funding to pay for imports and debt service if and when crisis hits. Given this role, there are at least two methods to evaluate the adequacy of reserves.

Method 1. Reserves should be large enough to cover three months’ worth of imports. On this measure Egypt’s reserves are only just about sufficient as both current reserves and quarterly imports stand at around $15 billion. This means that if Egypt lost all its income from tourism, Suez Canal and other exports and investments abroad, it would still be able to cover the cost of all its imports for three months. However, it would not have any funds left to service its debt.

Method 2. This method asks if a country can cope with a shock which simultaneously reduces exports, makes borrowing harder and results in capital flight. More specifically, it is assumed that the shock would result in a 10% drop in exports; 30% fall in short-term debt; 15% reduction in medium-and long-term debt; and 5% decline in broad money as a proxy for capital flight. For reserves to be considered adequate, they are recommended to be around 100-150% of the total loss of funds from the shock.

Without the Gulf’s aid, Egypt's reserves are below the safety range at around 78% of the potential losses under the scenario described above. Reserves should rise to about $21 billion with the Gulf support but that is still lower than the safety level of $25 billion implied by the method.

While the choice of the particular reserve-assessment method may be a matter of taste, the IMF has applied the second method in its recent agreement with Tunisia. Under this method, and even with the new deposits from the Gulf, Egypt's reserves are $4 billion short of adequacy and therefore need to be supplemented. The implication is that if Egypt decides to fill this gap with a loan from the IMF, it may need to negotiate a larger sum than $4.8 billion given its other fiscal and external needs.

Wednesday, 10 July 2013

Morsi’s deadly economic sin

The Muslim Brotherhood inherited a difficult economic situation, but their lack of coherent policies made things worse.

July 1st was the day after millions of Egyptians took to the streets to protest against the Muslim Brotherhood and their president, Mohamed Morsi. This was symbolic not because it resulted in the army’s removal of Morsi two days later, but because of the sheer scale of popular rejection of political Islam’s biggest party in the country where the ideology had been born.

The symbolism of 1 July extends beyond politics into economics. It is the first day of Egypt’s fiscal year in which the government’s new budget becomes effective. The process and the product of writing Morsi’s first (and last) budget encapsulates his administration’s approach to economic policy: an approach characterised by the absence of a clear plan and a preference for short-term fixes over long-term solutions under conditions which do not afford this luxury.

Having churned through three finance ministers during his one-year-and-48-hour term, Morsi’s budget was only approved by the Shura Council—Egypt’s upper house with temporary legislative powers—on 27 June. Despite the delay, there was no attempt to tackle the hard issues such as the persistence of large deficits (around 10% of domestic output) or the large subsidy provisions. As the table below shows, in terms of broad spending patterns and overall deficit size, Morsi’s budget (fourth column) does not look different from last year’s budget plan (second column) or last year’s actual turnout of spending (third column). If anything, his budget looks worse than his predecessor’s.

Egypt’s most urgent economic problem, namely its currency crisis, provides another example of Morsi’s economic management. For years, Egypt’s spending on imports has exceeded its revenue from exports. What prevented this from becoming a crisis under Hosni Mubarak was the inflow of foreign investments, which helped to finance the trade deficit. When these fled the country after the 2011 revolution, the Supreme Council of Armed Forces, which was running Egypt then, used up the significant international reserves to preserve the value of the currency. Morsi therefore inherited a chronic imbalance and depleted reserves, but his confused response ensured that the problem did blow up in his face.

Initially he sought the IMF’s help, reaching a preliminary agreement in November 2012. Presumably as a step towards implementing the agreed programme, he introduced consumption tax hikes on 9 December only to abandon them hours later. From that point onwards, he ceased to take the IMF option seriously despite other Egyptian officials’ repeated claims to the contrary.

Instead, he resorted to borrowing from Turkey, Libya and, especially, Qatar to finance the country’s foreign currency needs. As with the budget, he chose to coast along rather than face the fundamental problems heads-on.

There is a common theme running through these two examples and indeed others such as the ones highlighted by Rebel Economy. The Muslim Brotherhood inherited a difficult economic situation, but their lack of viable plans and reluctance to tackle difficult issues made things worse.