Crunch Time for Egypt’s Economic Reform

This blog originally appeared in Arabic on CIPE-Arabia.org. 

Indeed, Egypt is going through a very difficult period. The current economic situation is intrinsically linked to the accumulated weight of poorly addressed economic challenges over the past forty years.  Economic problems were either ignored, or in other instances, their root causes were not addressed in a profound and decisive manner.  On the other hand, undoubtedly, Egypt has all the capabilities to become one of the largest world economies.  This potential has been noted in reports of financial institutions such as the 2010 Citibank report.

The current difficulty stems from fact that there is no alternative to undertaking a comprehensive economic reform program. However, in the short run all Egyptians- the wealthy, the poor, and the middle class, will have to bear the brunt of these reforms. That said, with sound management of reform program, Egyptians will enjoy the fruits of reform in the medium to long run.

There can be no doubt that enacting economic reforms is crucial for Egypt’s progress. Thus, “No,” is my final unequivocal answer to the most critical question of whether Egypt has other alternatives to entering into the loan agreement with the International Monetary Fund (IMF).

We are currently facing many challenges.  Our prospects for a better future will be undermined if we deny these challenges or fail to work together to confront them.   We are face to face with a critical economic situation, even if we are not fully tuned in.  Egypt’s foreign currency reserves are actually in the negative, taking into consideration that the reserves include deposits of other countries. More so, the impact of the political situation on the economy cannot be overlooked.  In 2011 and 2013, Egypt witnessed two major political upheavals, which left their mark on the economy.  They disrupted economic reform efforts, undermined the overall security situation, and in effect, dismantled the overall framework governing the country.  Few well-rooted institutions remained intact, which saved Egypt from the state collapse.

Among the key challenges facing Egypt is the well-entrenched and cohesive corruption “system”, which voraciously rebuffs reform attempts, especially those related to commodities subsidies.  Attempts to subsidy reform have been fought hard by those benefitting from the corrupt system, as they are the prime beneficiaries of the current dysfunctional commodities subsidy scheme.  These beneficiaries include thousands of government employees along with others who, in turn, benefit from them.

In addition, Egypt faces other major challenges including:

• The widespread phenomena of the informal sector. As a result, a sizable proportion of economic activities fall outside the taxation net and the banking system.  As such, the national economy does not benefit from the potential contribution of these enterprises to its growth rate, and the state coffers are also deprived of potential tax revenues. Similarly, the informal sector stands to lose from remaining outside the framework of the national economy.  Informal enterprises are unable to take advantage of investment incentives offered by the state, such as export support or the initiative of the Central Bank of Egypt (CBE), which made available L.E. 200 billon for financing small and medium-sized enterprises (SMEs), at a 5% interest rate.  In addition, informal enterprises are also not able to take advantage of other opportunities including vocational training, industry modernization support, and other incentives available to formal enterprises.
•  Prevalence of monopolistic practices in a number of commercial and industrial activities, and ensuring compliance to quality standards, especially in light of the chaotic characteristics of market activities (sales, distribution, and display).
•  Bureaucratic barriers to market entry and exit.  Lengthy and cumbersome requirements for market entry (for registration or obtaining licenses and permits) could consume up to three years. As for market exist, bureaucratic hurdles can make it very difficult, and sometimes, impossible for firms to exit the market.
•  Existence of alternative parallel system.  Early on, in lieu of enacting structural reforms, and in an effort to simplify the regulatory framework, the state established a body of alternative procedures in a number of industrial and free zones. It should be noted that such parallel system should be viewed as only a temporary solution, a liminal stage, until the overall primary regulatory system that governs the operations of all entities, especially the SMEs, is fully reformed. I believe that Egypt has all what it takes to reform its primary regulatory system in a short time period.
•  The underutilization of approximately 95% of state-owned land and issues related to land appropriation to the different sectors including agriculture, industry, energy, tourism and commerce.  Fear, hesitation and populism, which drive the underutilization of state-owned land is a legacy of the negative experiences associated with the pre-1952 feudal system. This underutilized resource represent a significant wasted opportunity that can dutifully contribute to advancing Egypt’s economic growth and development.
•  Irrational consumption patterns resulting from a skewed subsidization scheme, which reduces cost for consumers compared to actual costs.  This subsidy scheme extends to a number of sectors including energy, water and consumer goods and services.
• A bad monetary policy-characterized by multiple exchange rates. This policy deters foreign investors from taking (calculated) risks and negatively affects foreign direct investment in Egypt.  Thus, reforming the monetary policy related to the exchange rate regime is of first-order importance, and should precede any discussions on economic reform measures. In this regard, an objective of the monetary policy reform should be to close the gap between the nominal exchange rate and the parallel market rate.
•  Prevalence of cash-based transactions across all market sectors and levels of the Egyptian economy.

Notwithstanding the severity of the current economic situation, one should not dismiss the number of successful reform-oriented initiatives undertaken by the government over the past three years. Notable initiatives included the introduction of reforms to the subsidy scheme and investments in national infrastructure projects such as roads, electricity and natural gas and oil exploration.

That said, while notable, as long as these initiatives are sporadic and not a part of a comprehensive reform program the likelihood of achieving their desired objectives is minimal.  A comprehensive reform program should include a detailed and clear action plan developed in consultation with the stakeholders, with the government relegated to a supporting role- providing incentives and enabling legislations and staying away from engaging in economic activities such as production.  The government has a range of tools at its disposal to support economic reform, including fine-tuning the monetary policy, facilitating financing, carrying out its monitoring and oversight function, preventing monopolistic practices, providing other incentives, encouraging investment, and enforcing the law.  Obviously, economic reform is multi-faceted process in which government, the private sector and civil society all have an important role to play.

What gives me a glimmer of hope in the IMF agreement is that, in compliance with the IMF’s requirements, Egypt developed a comprehensive economic reform program, which is subject to the IMF approval.  In this regard, economic reform will not be contingent on sporadic individual initiatives, which are not necessarily synchronized in a manner that is critical to the achievement of the overall reform goals.  Upon the conclusion of the agreement, Egyptian officials along with the IMF staff will oversee and track the execution of the program.  Therefore, it is safe to conclude that Egypt has now in place a comprehensive reform program designed to address the challenges cited above, and promote foreign direct investment, which is a lifeline for the Egyptian economy.

In this regard, there are a number of key considerations that should be borne in mind if Egypt is to optimize the benefits from the IMF agreement.  While fine-tuning the monetary policy remains critical and in the forefront, other key considerations include:

• SMEs are considered as the pillar of the economy in many countries.  Thus, it is important that reforms be designed to respond not only to the concerns voiced by big businesses but also they should reflect the voices of SMEs. While big businesses account for a small portion of businesses, SMEs represent 95% of all enterprises in Egypt.  More so, in attracting foreign direct investment, Egypt needs to expand its focus to include medium-sized enterprises, not only large ones.
• Reforming the domestic trade system is paramount due to its intersection with all stages of production as well as money circulation. Reforming domestic trade will also assist the government with effectively carrying out its market oversight and monitoring function.
• Expanding the market requires giving close attention to protecting competition and promoting anti-monopolistic behaviors and practices. Simplifying market rules and entry requirements by removing bureaucratic hurdles is key to achieving this.
• Facilitating market entry and exist is critical to integrating the informal sector in the formal economy.  As such, informal enterprises can contribute to Egypt’s economic growth and development.
• The Egyptian Parliament needs to enact a number of bills that were approved by the Cabinet.  These include:  The Industrial Development Bill, the Import and Export Bill, the Industrial Licensing Bill, and the One Person Company Bill.  Equally important, the government needs to expedite the finalization of the draft bills pertaining to investment and bankruptcy and present them to the Parliament. It should be noted here that advancing the industrial sector entails not only putting in place sound industrial policies, but also advancing other sectors including trade and export.
• We should not seek to fix or control prices.  Rather, we should focus on promoting a healthy economic environment that allows for the interaction of demand and supply to dictate the equilibrium price.  We should also avoid the pitfall of attempting to control trade. Market freedom is the real mechanism that can bring about growth and development.  Price monitoring should be relegated to consumer protections groups such as the case in developed countries.
• We should recognize that the problem is not with the Egyptian work force – the Egyptian worker is a skilled worker; the problem lies with good management.  Once good management practices are in place- ensuring that workers receive their rights and at the same time adequately carry out their duties and responsibilities, workers exhibit higher levels of disciple and commitment, which in turn is reflected in improvements in productivity.
• It is important to limit cash-based transactions in the economy.
• Careful consideration should be given to providing adequate support to public officials in their decision-making process.  To this end, there is a need to revisit the “Public Funds” provision in the Penal Code.  Amending this provision in a manner that strikes a good balance between safeguarding against corruption and not constraining the public official decision-making should have positive effect on the efficiency of decision-making by public officials.
• Rather than opting for “superficial reform” by creating parallel structures that offer temporary relief, efforts should focus on reforming institutional structures to ensure maximum benefits.
• Efforts to rationalize Egypt’s subsidy scheme and improve the targeting of subsidy-eligible recipients has already began, and should be continued. This entails implementing a more effective approach whereby subsidies are targeted by eligible recipient rather than commodity.
• Due attention should be given to privatization, or at minimum, separation of state ownership from management.  It is worth noting that privatization in some countries such as China is used as a development tool, where proceeds were used to finance the development of civil society.

In conclusion, we have to recognize that Egypt has little room to maneuver on the economic reform front.  In spite of the harshness associated with such reforms, Egypt has to commit to undertaking the needed reforms, which are stipulated in the IMF agreement.  The option of procrastinating with reform and continuing with the deteriorating state of affairs is an untenable option that can result in complete chaos.

Tarek Tawfik is Deputy Chairman of the Federation of Egyptian Industries, Chairman of Cairo Poultry Group, and former Chairman of the Chamber of Food Industries.