On July 10, 2014, President Abdel Fattah El Sisi signed the decree that approved Egypt’s budget for the fiscal year 2014/15, reflecting his intention to reduce the national deficit from 14% to 10% of GDP. The president’s decision is a step in the right direction towards regaining stability. The government has set a total spending budget of LE790bn ($112.2bn), compared to LE737bn ($104.7bn) during the previous year.
The new budget is markedly different because the Egyptian government is beginning to rein in rising subsidies, which have reached LE180bn ($25.6bn), with LE130bn ($18.5bn) of this directed to energy. Subsidies represented 25% of the budget and are responsible for the large deficit, at LE350bn ($49.7bn), as well as swelling domestic debt, equivalent to national GDP. Indeed, energy subsidies grew from LE40bn ($5.7bn) to LE130bn ($18.5bn) from 2007-13. Accordingly, the situation urgently called for tighter spending polices and control. The government will reduce energy subsidies by LE40bn ($5.7bn) in the proposed budget, taking the necessary decision to implement reductions by raising prices of gasoline, diesel, electricity and gas.
The new budget also introduced some new structural reforms. The tax rate for individuals and corporations earning more than LE1m ($142,000) per year has been increased to 30%, up from 20% in 2012, and for the first time, a new tax of 10% was imposed on realised capital gains and dividend payouts from securities.
How should these changes be interpreted? Reduced spending and tax increases are tight fiscal policies that will be concurrently implemented at a time when the economy is experiencing a slow-down and high inflation. These policies are both bold and necessary and should have been implemented long ago, but the government previously failed to take immediate action. Nevertheless, the restrictive nature of the policies will have negative, unintended repercussions. The government should be prepared to minimise their impact by first increasing the price of energy, leading to an increase in the prices of products and services in the economy, resulting in higher inflation, currently at 10%. The new measures will also reduce disposable income available for consumption and investment, which will further reduce economic growth, currently at an anaemic rate of 2%. Last but not least, an expected rise in the unemployment rate, already at 12%, should not be overlooked, with a weaker economy unable to absorb the yearly addition of new entrants into the labour force.
The government will have to monitor negative repercussions resulting from the implementation of its reform programme and take corrective action to contain social implications, such as monitoring the market and prices to quickly prevent faulty behaviour from continuing. Some degree of budget flexibility in order to introduce additional spending programmes to reduce unemployment is also recommended. Most importantly, administrative hurdles and inefficiency must be tackled.
A friendly investment environment should be fostered to receive new investments from Egypt’s Economic Summit, scheduled for February 2015. The best way to offset tight fiscal policy is attracting foreign direct investment to create jobs and boost economic activity. The second phase of the reforms should include a serious effort to broaden the tax base to incorporate the informal economy, with the help of outside experts. Additionally, reflecting on the experience of countries that successfully overcame similar challenges is necessary. The government should expand its use of fees instead of only relying on direct taxation, as there is a limit beyond which policies have adverse effects.
The government must reform its administrative functions to contain salaries and wages, which account for 25% of the budget. It must also send a clear message that it supports the private sector and encourages private ownership and individual initiatives, and must make clear that its primary role is to regulate and supervise economic activity, not dominate it. Indeed, the private sector employs 70% of the workforce. The latest decisions are bitter but necessary medicine that should be supported for Egypt to regain growth and stability.
Read More from OBG
