Faced with major internal and external imbalances, the Egyptian government in November 2016 implemented a three-year economic reform program supported by the International Monetary Fund (IMF). The program focused on restoring the balance of the economy through major reforms in the areas of fiscal, monetary, and exchange rate policies; reforming energy subsidies; improving government finances through the implementation of the value-added taxes (VAT), and applying an improved system for social safety nets. The program also included structural reforms in the energy sector, privatization, improved infrastructure, and investment climate.
As the program reached its conclusion in November 2019, with significant improvement in containing domestic absorption and in some structural issues, challenges remain for sustainable and inclusive economic growth. Domestic private investment still needs stimulation and foreign direct investment (FDI) – aside from the energy sector – is still weak. Moreover, privatization is lagging, human capital development continues to be problematic, and major issues related to red tape, inefficiency, and redefining the roles of public and private sectors persist.
Accordingly, a new phase of economic reforms is needed to tackle the remaining problems on the supply side of the Egyptian economy to increase its efficiency and to achieve sustainable and inclusive economic growth.
Economic problems before November 2016
The Egyptian economy suffered from major inefficiencies, distortions, and imbalances from January 2011 till November 2016. It faced increased pressures resulting from slow economic growth and high levels of unemployment, because of the lack of private investment, both local and foreign. The economy suffered from high levels of inflation and crowding out of the private sector as a result of an expansionary fiscal policy – mainly because of exceptional social spending. This led to an expanding budget deficit increasingly financed directly from the Central Bank of Egypt and the domestic banking system in the form of accommodating monetary policy.
These expansionary fiscal and monetary policies caused major internal and external imbalances. Egypt suffered from expanding twin deficits in both the government budget and the current account of the balance of payments (BoP). As the current account deficit expanded, the lack of FDI, the reversal of portfolio investment flow, and the increased difficulties of accessing the international financial markets drained foreign reserves, creating a parallel market for the foreign exchange and exerted intense pressure on the official exchange rate.
Meanwhile, a long history of import substitution strategies, heavy energy and electricity subsidies, an overvalued nominal exchange rate, and negative real interest rates, led to major economic distortions and inefficiencies. It also led to a bias in favor of energy and capital-intensive import substitutes, while working against labor-intensive, export-oriented industries that are most efficient for labor endowed Egyptian economy.
Human capital development in Egypt also suffered from the lack of fiscal space as wages, subsidies and interest payments took over government expenditure. This hampered the pursuit of efficiency for economic growth and caused deterioration of Egypt’s rankings in healthcare and education in the international indicators.
Finally, the lack of funding and the instability that set in after January 2011 led to a deterioration in infrastructure and shortages of electricity and water supplies. The over-employment in the public sector, lack of access to financial services, red tape, widespread corruption, regulatory bottlenecks, and legislative rigidity resulted in a deterioration in the Ease of Doing Business and Global Competitiveness indicators for Egypt.
Reforms and achievements
Faced with mounting imbalances and inefficiencies, Egypt chose to enter into a reform program, from November 2016 to November 2019, supported by a US$12 billion extended arrangement with the IMF. The objectives of the program included restoring macroeconomic stability, reducing the budget deficit and public debt, promoting inclusive growth, creating jobs, correcting external imbalances and restoring competitiveness while protecting the most vulnerable groups of the Egyptian society from the costs of reforms.
The program worked on performing significant policy adjustments, structural reforms and creating social safety net through a comprehensive set of actions as follows:
Exchange rate reform
On November 3, 2016, and before signing the IMF Agreement, the Central Bank of Egypt surprised the markets by announcing a devaluation of the Egyptian Pound by 32.5 percent against the US Dollar. Within a few days, the Central Bank removed restrictions on setting rates by banks, allowing the exchange rate to be floated and to be market-determined without intervention.
During the first phase of the reform program, the Central Bank raised the policy interest rates significantly (by 700 basis points). It set an official mechanism for foreign investors in government securities to guarantee the availability of foreign exchange through official channels while repatriating funds. The significantly higher domestic interest rates, the floating exchange rate, and the repatriation mechanism helped in attracting large inflows of foreign portfolio investment. They also encouraged the residents of Egypt to reverse the dollarization phenomenon that prevailed before the reform program and helped tremendously in rebuilding the international reserves at the Central Bank of Egypt.
Later on, during the late phase of the reform program, and after a significant period of international reserves building and regaining the confidence of foreign investors in the Egyptian Pound, the repatriation mechanism was halted after it had achieved its objectives. With the continued inflow of portfolio foreign investment, plus a robust performance from the tourism sector and workers’ remittances, the Egyptian Pound experienced a significant period of appreciation against the US Dollar.
Monetary policy reforms
The Central Bank worked to contain inflation initially by tightening the monetary policy via consecutive increases in policy interest rates and halted excess liquidity in the money market by introducing deposit auctions for the banks. The Central Bank also worked on strengthening its independence and preventing the dominance of the fiscal policy over the monetary policy by signing a protocol with the Ministry of Finance on limiting direct Central Bank financing of the budget through overdrafts.
During the program, and after floating the exchange rate, the Central Bank chose a monetary policy framework based on money targeting, while setting the grounds for implementing inflation targeting in the future. The monetary policy was set to focus on bringing the inflation rate down to single digits in the medium term, and a target for the inflation rate was set at 9% ± 3% for the fourth quarter of 2020. The Central Bank worked on increasing the effectiveness of the monetary policy through controlling credit to government, by strengthening its capacity to forecast and manage liquidity, by improving transparency and communication mainly through issuing a quarterly Monetary Policy Report and an annual Financial Stability Report.
Fiscal policy reforms
The 2016 reform program tackled the fiscal policy reforms as the main element to prevent any public debt problem and to ensure its sustainability. To achieve this objective, the program targeted maintaining a primary budget surplus (i.e. before taking into account the interest payments on public debt) of 2 percent of the GDP to guarantee a declining public debt and to have fiscal space for spending on priorities such as infrastructure, healthcare, and education.
To achieve the targeted primary surplus, tax revenues were set to increase largely through the implementation of the VAT, while primary expenditures were to be reduced through the reduction of subsidies and containing the wage bill. To reduce subsidies, energy prices were raised regularly to achieve a pre-tax full cost recovery for fuel by 2018/19, and to eliminate electricity subsidies over five-years.
The 2016 reform program included several structural reforms intended to increase the efficiency in the economy. The program was meant to remove the obstacles facing sustainable inclusive growth, which limited the job creation among the youth. These reforms included measures for improving public finance management, simplifying business regulations, strengthening governance in general and specifically in public enterprises. Also, the energy sector reforms were planned to modernize the sector by improving the regulatory framework for enabling private investments and promoting competition.
Other structural reforms included improvement of the licensing regime and the introduction of a one-stop-shop for licenses. A new law was formulated for single proprietorship companies, and for abolishing industrial licensing except industries that affect vital public interests. A new insolvency law was drafted to be in line with the best international standards, to simplify bankruptcy procedures and to de-criminalize insolvency. A resumption of privatization was envisaged through the announcement of a five-year IPO program as part of the government’s agenda to improve the management of public assets, and to attract private investment, and was accompanied by the setting up of a new sovereign wealth fund.
Egypt also worked on strengthening the public procurement system to increase its transparency, fairness, reduction of corruption, and to optimize public spending. A new Government Procurement Law was approved, and worked on standardizing government procurement processes to encourage broad and competitive participation by the private sector, and applied uniformly on all government entities’ tenders covered by the law, and to ensure that the procurement rules are consistent with best practices. Also, public procurement is planned to move from a paper-based system to a single e-procurement portal.
Other structural reforms targeting the improvement of the business climate included the establishment of a collateral registry to facilitate access to finance especially for the Small and Medium Enterprises (SMEs), and implementing reforms for the export promotion regime and minimization of the non-tariff barriers to trade.
Social safety net reforms
The reform program took into consideration the need to protect the most vulnerable groups in the society through numerous measures that included an additional 1 percent of GDP increase on food subsidies and cash transfers to the poor through the social programs of Takaful and Karama. Better targeting of food subsidies was planned through improving the smart card system for essential food rationing.
Main achievements of the reform program
The program succeeded in improving almost all the macroeconomic indicators for the Egyptian economy as the real GDP growth increased from 4.3 percent in 2015/16 (fiscal year starts July 1st) to 5.5 percent in 2018/19 and was estimated to be 6 percent in the medium term. Meanwhile, the unemployment rate declined from 12.7 percent in 2015/16 to 8.8 percent in 2018/19. As for the inflation rate, the initial evaluation and adjustment of fuel prices led to a spike in it to reach 29.8 percent in 2016/17, but the prudent monetary policy that tackled the second-round effects led to a continuous decline of the inflation rate to reach 12.4 percent by the end of 2018/19.
As for the budget sector, the consolidation efforts succeeded in switching the primary deficit of -3.5 percent of the GDP in 2015/16 to a primary surplus of 2.0 percent in 2018/19, which led the overall budget deficit to decline from -12.5 percent of the GDP to -8.2 percent for the mentioned dates consecutively. The primary surplus and the declining overall deficit led the public debt to decline as a ratio of the GDP from 96.9 percent in 2015/16 to 85.2 percent in 2018/19, which helped in limiting the inflationary pressures and the crowding-out effect on the private sector.
|Real GDP Growth Rate (%)||4.3||5.5||6.0|
|Unemployment Rate (%)||12.7||8.8||7.5|
|Inflation Rate (%)||28.9 (2016/17)||12.4||7.4|
|The Budget Sector|
|Primary Budget Balance (% of GDP)||-3.5||+2.0||+2.0|
|Overall Budget Balance (% of GDP)||-12.5||-8.2||-5.6|
|Public Debt (% of GDP)||96.9||85.2||79.2|
|The External Sector|
|Trade Balance (% of GDP)||-14.5 (2016/17)||-12.8||-11.5|
|Current Account Balance (% of GDP)||-5.6 (2016/17)||-2.5||-2.1|
|International Reserves (US$ bn – end of fiscal year)||17.1||43.9||44.5|
|International Reserves (covering months of imports)||3.0||5.9||5.4|
On the external sector front, the initial devaluation then floatation of the exchange rate helped in improving the trade balance as a percentage of the GDP from -14.5 percent in 2015/16 to -12.8 percent in 2018/19. On the other hand, the fiscal consolidation and the prudent monetary policy helped in limiting the internal imbalances and improved the external imbalance of the current account of the BoP to register a decline in its deficit as a ratio of GDP from -5.6 percent in 2015/16 to -2.5 percent in 2018/19.
Meanwhile, the resumption of the portfolio investment inflows to Egypt, and the return of its ability to access the international financial markets under favorable conditions, let the capital and financial account of the BoP to register surpluses that helped Egypt in rebuilding its international reserves from a merely US$ 17.1 billion covering three months of imports by the end of 2015/16, to US$ 43.9 billion covering 5.9 months of imports by the end of 2018/19.
Challenges to sustainable economic growth
Even as the IMF program significantly contained domestic absorption and resolved some structural issues, challenges to sustainable and inclusive economic growth remain in Egypt. Domestic private investment still needs stimulation, FDI is still weak and Egypt is heavily dependent on external debt flows and foreign portfolio investment in government securities to close its external financing gap. Also, privatization and public-private-partnerships are lagging, human capital development is still problematic, and major issues related to red tape, inefficiency, and redefining the roles of public and private sectors persist.
The major criteria for improving the supply side of the Egyptian economy could be looked at from the international comparisons related to the efficiency and competitiveness of Egypt as reflected in two major indices, and their sub-indices, that track the following aspects:
Performance under the Ease of Doing Business Index
|Ease of Doing Business Rank||128 (of 190)||114 (of 190)|
|Starting a Business||103||90|
|Dealing with Construction Permits||66||74|
|Protecting Minority Investors||81||57|
|Trading Across Borders||170||171|
Source: Doing Business Reports, World Bank Group.
Egypt’s overall ranking in the Ease of Doing Business index improved with the implementation of the 2016 reforms program. The overall ranking improved by 14 places between 2017 (measured in the 2018 report), and 2019 (measured in the 2019 report). However, Egypt has a long way to go in achieving a dynamic, hospitable business environment for the private sector as its overall ranking – even after the improvement – still needs a lot of improvement as it ranks 114 among 190 economies.
While considering the areas that need maximum improvement, and should be considered as a priority, the following could be considered as the top five areas in need for reforms:
Global Competitiveness Index
|The Global Competitiveness Index Ranking||100 (of 137)||93 (of 141)|
|Macroeconomic Environment / Macroeconomic Stability||132||135|
|Health & Primary Education / Health||87||104|
|Higher Education & Training / Skills||100||99|
|Goods Market efficiency / Goods Market||90||100|
|Labor Market Efficiency||134||126|
|Financial Market Development / Financial System||77||92|
|Technology Readiness / ICT Adoption||94||106|
|Business Sophistication / Business Dynamism||84||95|
|Innovation / Innovation Capability||109||61|
Source: The Global Competitiveness Reports, World Economic Forum.
Egypt’s overall ranking in the Global Competitiveness index improved with the implementation of the 2016 reform program, as its overall ranking reached 93 out of 141 countries in 2019 compared to 100 out of 137 countries in 2017/18.
To improve efficiency further, and to enhance the competitiveness of the Egyptian economy and its integration with the global economy, the following areas need further improvement and should be considered as a priority for the next step of reform:
Based on the performance of the Egyptian economy in creating a suitable climate for the development of private, medium, and small firms that creates jobs and achieves sustainable and inclusive growth in the “Ease of Doing Business Index”, and its performance in efficiency and dynamism needed to play a more active role in the global economy and to achieve a higher degree of integration reflected in the “Global Competitiveness Index”, an integrated framework for the next set of reforms should form the basis of structural and social policies for the medium to long term.
CHEP: A policy framework for sustainable growth
CHEP is an integrated structural reform framework that covers the areas mentioned in the previous section where the achievements could be measured through continuous improvement in the Doing Business Index, and the Global Competitiveness Index. The suggested framework covers four major pillars – Competitiveness Improvement, Human Capital Development, Efficiency Enhancement, and Private Sector Participation.
Competitiveness Improvement: Egypt should look at optimizing the use of resources to reflect its comparative advantage stemming from this labor-abundant country. Achieving such an objective would help Egypt in improving its external competitiveness in a framework that targets a more open economy, integrated with the global economy. To achieve this objective, the following is required:
Human Capital Development: As discussed earlier, Egypt’s comparative advantage lies in its labor-abundant characteristics. Accordingly, to unlock the full potential of the Egyptian economy, the priority should be given to the continuous improvement of its labor force. This will require the following:
Efficiency Enhancement: Improving efficiency in market mechanisms and areas such as ICT, accompanied by an increased degree of financial inclusion are key elements in achieving sustainable and inclusive growth in developing countries and emerging markets. Key reform areas are as follows:
Private Sector Participation: Increasing the relative importance of the private sector contribution to economic growth is the key to efficiency and sustainable and inclusive growth. This should be done through allowing the space for the private sector to flourish by minimizing the crowding-out effects of increased public sector activities, solving the hurdles facing private investment, and working on creating public-private partnerships (PPP) in expanding areas of developing infrastructure and key projects by the government:
Even as the Egyptian economic reform program with the IMF ended with significant improvement in containing domestic absorption and in some structural issues, challenges remain for sustainable economic growth. Domestic private investment still needs stimulation, FDI is still weak, privatization is lagging, human capital development is still problematic, and there are major issues related to red tape, inefficiency, and redefining the roles of public and private sectors.
Accordingly, a new phase of economic reforms is needed to tackle the remaining problems on the supply side of the Egyptian economy to increase efficiency and to achieve sustainable economic growth. These reforms should target the policies related to improving human capital, increasing the role of the private sector through – enter alia – activating privatization and encouraging PPPs, removing the remaining distortions, cutting red tape, and working mainly on achieving significant improvements on Egypt’s global ranking in almost all components of the Human Development Index, the Doing Business Index, and the Global Competitiveness Index.
To achieve sustainable and inclusive growth, a policy framework for enhancing the supply side of the economy, driven by improving Egypt’s global ranking in the components the Doing Business Index, and the Global Competitiveness Index, is recommended. This policy framework works on reforming four major pillars, with the acronym (CHEP), namely: Competitiveness Improvement, Human Capital Development, Efficiency Enhancement, and Private Sector Participation.