Patrick Werr: Egypt caught up in a vicious circle with its finances

Egypt’s finances have entered a vicious downward cycle, with the government’s stopgap measures to fix problems in the short term merely compounding the problem in the longer term. Simple arithmetic tells you something eventually has to give. The government needs to sit down and have a serious conversation with its people on how dire the situation is and explain why serious sacrifices are needed all round.

Please bear with me as I lay out numbers and statistics, taken mainly from websites of the finance ministry and the central bank.

One of the government’s most intractable problems is the budget deficit, which in the year that ended June 30, 2015, was equivalent to 11.5 per cent of GDP, among the highest in the world.

Among major economies, only oil-dependent Venezuela, at 109.9 per cent, and Saudi Arabia, at 18.8 per cent, were doing worse, mainly as they adjusted to a steep fall in oil prices. Among countries not so dependent on oil exports, only Brazil, at 10.3 per cent, came close to Egypt.

In the six months from July to December, Egypt’s deficit increased even further, rising to 191.6 billion Egyptian pounds (Dh65.63bn) from 159.1bn a year earlier. Incredibly, this represented almost half of all government spending. Of Egypt’s 405.2bn pounds in spending, almost a third went to pay interest incurred to finance previous deficits. Another 20 per cent went to pay for subsidies, mainly of bread and energy.

The dilemma has long been how to finance the deficit. For many years, foreign investors were all too willing to buy Egyptian treasury bills, which added competition and pushed down interest rates. But most fled after the 2011 uprising, leaving the government to rely mainly on local banks and international handouts.

Within two or three years, however, the cash available at banks reached its limit. It seems the government some time in early 2013 took the strategic decision to borrow from the central bank, which in effect meant printing money (metaphorically) to pay its bills, something it appears still to be doing.

In the last half of 2015, the central bank’s “net claims on government” rose to 679.23bn pounds, from 585.39bn at the end of June, an increase of 93.84bn. Only 38.9bn of this was accounted for by a draw-down of foreign assets. The rest seems to have been pure money creation.

London-based Capital Economics estimates that since the beginning of 2013, the government has financed 10 to 15 per cent of its budget deficit by borrowing from the central bank. This would mean the government now borrows more from the central bank than from commercial banks.

This could explain why Egypt’s money supply has been growing so quickly: M2 grew by 17.5 per cent in the year to end-February.

The problem with creating new pounds is that the more there are, the less value they have against goods and services inside Egypt. In other words, more pounds chasing the same amount of goods and services causes prices to rise. And indeed, at 9 per cent, Egypt’s annual inflation rate is now second highest among the world’s top 42 economies, just behind Brazil’s 9.4 per cent.

Creating new pounds also means the Egyptian currency loses its value against foreign currencies.

The 2011 uprising and the continuing political instability since then, which caused dollar-toting tourists and investors to flee, had already put the pound under pressure.

Before the 2011 uprising, tourism had been growing steadily, earning the country $12.5bn in 2010, or more than 10 per cent of GDP, and employing about 12 per cent of the workforce. But by 2015 it brought in only $6.1bn, and in the first quarter of 2016, after the bombing over Sinai of a Russian airplane in October, the industry took in a paltry $500 million.

Other dollar sources have also eroded. Suez Canal revenue, hit by a decline in world trade, fell 5.3 per cent in 2015 to $5.18bn. From July to December, Egyptians working abroad sent $1.1bn less home than the previous year, for a total of $8.28bn. As a result, the current account deficit in the six months soared to $8.92bn from $4.31bn a year earlier. The only good news was that Egypt shaved $656m off its net import bill for petroleum.

Egypt’s enormous deficit has created a vicious circle. Borrowing money to finance it means bigger budget deficits down the road. Printing money, on the other hand, creates inflation. If the government doesn’t increase the price of subsidised goods to match this inflation (which it rarely does), the cost of the subsidies rises as well.

It is unsustainable.

Patrick Werr has worked as a financial writer in Egypt for 25 years.

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