Egypt’s dire need to wean off subsidies

This article appeared originally in Gulf News: link to original article

If you reckon that having a subsidy is OK, the question then turns to how much of it should be there? What should be subsidised? What percentage should it be of the country’s overall gross domestic product? And is it right to classify subsidies as government spending?

In many countries, subsidies exit in different forms. In Malaysia, these are mostly found in energy. Indonesia has subsidies for fuel, where it costs the government some $20 billion a year. Thailand provides some $4 billion in rice subsidy, as the government buys the staple from farmers at market prices.

The US previously provided food stamps — another form of subsidies. Egypt, the main example that will be discussed here; has a different system of subsidies that account for around 14 per cent of its $250 billion GDP.

According to a study by the World Bank in 2005, the types of subsidies and the extent of them were as follows: food (61.4 per cent); Baladi bread (67 per cent); 10-Piaster bread (47 per cent); ration cards B, including sugar, oil, tea, ghee, beans, lentils, rice, and pasta (37 per cent). That for electricity (9.5 per cent) varies according to consumption; with that for energy at 75.7 per cent, LPG’s 88 per cent, gasoline at 47.6 per cent, kerosene (81 per cent) and natural gas (79.7 per cent).

The percentage of subsidies of the overall GDP then was 10.3 per cent, and has since increased to 14 per cent. In 2004, one out of every five Egyptians lived in poverty, and it was one in every four by 2011. The same study identified poverty as an average annual consumption per capita of Egyptian lira of 1,438. The government spends a third of its budget on subsidies, with fuel-related subsidies increasing from 8.1 per cent of government spending in 2004 to 20 per cent.

In 2013, food subsidies alone ate up $4.5 billion, with two-thirds going to bread-related subsidies. Egypt is the largest importer of wheat by the way. The concern is whether Egypt’s economy can support such an expensive subsidy system with a population that exceeded 86.8 million (in 2013) and projected to grow by 1.8 per cent, especially with more countries realising that subsidies are ineffective in reducing poverty.

To better understand the implications of such a subsidy programme, let’s have a look at Egypt’s financials.

Egypt spends more than it generates in revenues, relying heavily on tourism and Suez Canal income for foreign currency. Before 2011, tourism accounted for $27.5 billion of Egypt’s economy, or 11 per cent of it.

The Suez Canal annual income exceeds $5 billion. Egypt’s revenue collection was $45.57 billion in 2013 according to the CIA Fact Book, and also takes into account remittances by Egyptians working abroad, foreign aid, and tax income.

Expenditure in 2013 amounted to $80.42 billion, implying a fiscal deficit of 13.54 per cent of GDP. This was 5.7 per cent of GDP in 2004. A fiscal deficit, in Keynesian terms, is supposedly good as it implies higher government spending that can eventually get countries out of recessions.

For Egypt, this is not the case. Subsidies are a third of government spending, and the remainder goes for spending on education, health care, etc, in addition to interest payments made on its public debt that stood at 92.2 per cent of its GDP in 2013.

The same was 76 per cent in 2004, with the increase justified by the need to finance the annual deficit that Egypt’s government has been reporting since. Given all of this, can Egypt seriously retain its subsidy programme? If not, what’s the solution and how long will it take for winds to start blowing in a favourable direction?

Whichever way you look at Egypt’s subsidy programme, it cannot be sustained. If anyone says otherwise, then the country is either eating through its public spending to do it or expecting foreign aid to support that.

Pressure on currency

When a country faces economic problems, downward pressure is exerted on its currency. Different tactics are then employed by the central bank to defend the currency and the economy from a collapse. For a country that is significantly dependent on tourism for foreign currency, not stashing enough reserves can be problematic in times of despair.

That along with the capabilities of Egypt’s Central Bank was tested in 2011. Early in 2011, foreign currency reserves in Egypt stood at $36 billion. In a year’s time, that dropped to $14.93 billion as the Central Bank burnt through some $20 billion to back its currency from depreciating too much.

Controls were put in place to limit selling $40 million to banks three times a week; withdrawals limited to $10,000 a day, and a $100,000 a year cap on Egypt’s outbound transfers. With the drop in tourism, these reserves could not be replenished.

That being said, allow me to remind you of the IMF’s $4.8 billion loan negotiations that took place in 2012, and which was probably going to support the currency reserves and the Egyptian pound with it. Or it would have gone to bridge the fiscal gap that subsidy programmes created and widened.

In 2013, and as a sign of hope, Egypt’s Central Bank’s reserves increased to $17.03 billion, thanks to cash infusion from Saudi Arabia, the UAE, and Kuwait, as well as the lifting of travel bans by a few countries. The IMF now estimates growth in Egypt’s GDP at 2.8 per cent, higher by 1 per cent than its projection for 2013.

Subsidy programmes are a problem, never a solution. IMF estimates that 43 per cent of fuel subsidies end up with the richest 20 per cent in the country. The International Energy Agency (IEA) estimates that when lost tax revenues are added, fossil fuels subsidy expenditure can amount to $2 trillion.

Getting rid of subsidies

Countries are either getting rid of subsidies or looking at ways to do so. Indonesia increased petrol prices by 44 per cent to get rid of its hefty fuel subsidy bill. Malaysia ended its energy bills’ subsidy, and prices went up by more than 10 per cent.

Both resulted in inflation, and inflation leads normally to the dilution of public debt. Egypt is aiming to cut fuel subsidies by 25-30 per cent in five to six years. It previously got rid of its gasoline subsidy — recommended by the World Bank study in 2005. If further cuts take place, inflation might even get to be higher than the 9 per cent recorded in 2013 by the CIA Fact Book.

Can’t be good news for a country with a mounting public debt. But a consequent drop in currency value is not bad either. Cheaper currency attracts investments’ however, it could also scare away existing holders of assets in that currency.

The World Bank study concludes that the most effective replacement for subsidies is well-directed cash transfers, which creates a social safety net for the poorest percentile of the economy. That should not only eliminate subsidies going to the rich, but should rid the economy of energy bill subsidies benefiting the manufacturing industries.

This might as well save Egypt from the six-hour power cuts that is being instituted this summer (EIU). Private investors also need to be provided with the means to encourage investments such as business forums, like the Egypt-GCC one that took place in Cairo in December. Also needed are entrepreneurial seminars for SMEs to create employment among a population where 50 per cent are below 25 years and where youth unemployment is at 25 per cent.

This will, hopefully, increase overall income and consumption per capita, and do a better job at targeting poverty. The thought that I want to leave is: Good Luck, Egypt.

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