Egypt’s political economy must truly be characterize as crackpot, dysfunctional and totally dependent on foreign aid and relief. Egypt likes to play its hand as a too-big-to fail nation that can make trouble.
Egypt’s post-revolution budget deficit and debt have increased at an accelerating rate as the pound’s diminishing value and high global commodity prices drove up Cairo’s subsidy bill, which accounts for at least 27% of all government spending. There has also been increased spending on social benefits, a key demand of the revolution. Overall, subsidy and social-benefit spending rose 49% from July 2012 to January 2013 compared to the same period the previous year. The budget deficit rose by 36% to $17.7 billion that period and is projected to increase between $27 billion and $34 billion by July.
With Egypt’s international credit rating repeatedly downgraded, the government has been forced to finance enormous deficits by relying almost exclusively on domestic debt, which last year rose $34 billion to reach $184 billion, or almost 70% of GDP. The 2013/2014 budget-deficit target is 9.5% of GDP. Egypt has $35 bn in external debt: $10.8 bn to the EU, $4.2 bn to Japan and $3.1 bn to the U.S. Reflecting the global high yield bond bubble, Egyptian debt issued in U.S. dollars is still only 591 basis points over Treasuries. The hit from a default will be largely domestic, which will serve to further sink the country into depression.
A wasteful system of food and fuel subsidies is in place that gobbles up some $20 billion a year. Diesel alone, which powers the pumps irrigating Egypt’s farms, accounts for $7.5 billion in subsidies and is sold to consumers at the equivalent of 16 cents a litre, whereas most Europeans pay $2 or more
At the same time and because of the need to import food in particular, there has been a staggering decline in Egypt’s foreign exchange reserves, from almost $37 billion before the revolution to about $13.5 billion today. Additionally, Egypt has about $4 billion in gold. The reserves are only enough to cover three months of imports. Economists say further devaluation is inevitable — and a steep drop in the exchange rate could bring painful inflation and more social unrest. The problem is that Egyptians, most of whom are poor, already devote most of their income to food. People who are hungry will hit the streets or worse, revolt.
To reverse this, the Morsi government appears to have pinned its hopes on two external sources of capital: begging and a form of post-facto capital controls, or trying to recover money that has left the country. This is money supposedly held abroad by former officials of the Mubarak government. Yet, Egypt’s finance minister recently announced that less than $15 million in such funds had been recovered to date, despite domestic media reports that billions were available for recovery. The final return on these efforts will likely be disappointing due to international legal challenges.
On the begging front, Cairo is also pursuing a stand-by agreement with the International Monetary Fund amounting to $4.8 billion, along with several billion in additional aid from the U.S., Europe and elsewhere, which is dependent on an IMF deal. Egypt and the IMF reportedly reached a tentative agreement in late 2012 on a reform plan, but Cairo reneged on mandatory tax within hours of announcing them, nullifying the agreement.
Although many observers expect the IMF to soften its terms — whether because Egypt is too big to fail or in response to pressure from the Obama administration, which has strongly backed Morsi — the agency has held fast. The IMF and other donors are undoubtedly cognizant that giving Egypt money under the current circumstances would merely extend the time it takes for Cairo to exhaust its foreign reserves, without addressing the country’s underlying economic problems.