IMF Executive Board Concludes 2007 Article IV Consultation with the Arab Republic of EgyptPublic Information Notice (PIN) No. 07/139
December 3, 2007
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On November 28, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Arab Republic of Egypt .1
Sustained and bold reforms, prudent macroeconomic management, and a favorable external environment enabled the Egyptian economy to register another year of impressive performance. Growth remained high and has become more broad-based, creating record numbers of jobs. Inflation has returned to single digits after spiking during the year through March 2007. Investor confidence remains high.
Real GDP growth in 2006/07 is estimated at 7.1 percent, the highest in years. The expansion was broad-based, with a further acceleration in non-hydrocarbon sectors, including in agriculture and manufacturing. The growth since end-2004 has added 2.4 million jobs as of end-March 2007, reducing unemployment from 10.5 percent to 9 percent.
Strong growth and rising equity and real estate prices have boosted domestic demand, contributing to strong import growth and a pick-up in underlying inflation. Exports also rose sharply, along with worker remittances, Suez canal receipts, and tourism revenues. With record levels of Foreign Direct Investment, the balance of payments recorded a surplus of US$5.3 billion in 2006/07, bringing official reserves to the equivalent of more than 6 months of imports of goods and services. A spike in inflation over the year through March 2007 was driven largely by the impact of an avian flu outbreak and adjustments in administered fuel prices in 2006; but a rise in underlying inflation (one that excludes food and most energy prices) points to some spillovers and demand pressures as well, along with some imported inflation. After peaking at 12.8 percent in March 2007, inflation measured as the Consumer Price Index has gradually receded since, to 8.5 percent in August; underlying inflation has also fallen substantially.
Macroeconomic policies in 2006/07 helped contain demand and inflationary pressures, but were complicated by strong capital inflows. Monetary policy was tightened once spillover effects of administered price increases became visible, and the nominal exchange rate allowed to appreciate by 1.1 percent against the U.S. dollar in the year to end-June, with considerably greater flexibility since then. Through the partial sterilization of external inflows, broad money growth was kept in the 13-15 percent range until April 2007, but subsequently surged to 18 percent.
Fiscal imbalances narrowed as there was significant underlying adjustment in 2006/07. Preliminary data indicate a central government deficit of 7.5 percent of GDP, below the 9 percent average of recent years, largely due to structural improvements in the tax area, fuel price adjustments, wage restraint, and windfall receipts from a telecom license sale, with a broadly similar adjustment for the general government (which includes social security funds and the National Investment Bank, NIB). Combined with privatization receipts and the draw-down of idle cash balances following the consolidation of most government accounts into a Treasury Single Account, budget borrowing requirements fell dramatically, contributing to a decline in Treasury-bill yields.
Structural reforms advanced significantly in promoting a private-sector driven economy. The fourth largest state bank (Bank of Alexandria) and a large department store chain along with other assets were sold to foreign investors (about 1.4 percent of GDP). Import tariffs were reduced in early 2007, and tax administration reforms progressed. Cash and debt management was streamlined by consolidating government accounts into a treasury single account and by the settlement of circular debts among the central government, the NIB and the Social Insurance Funds. Plans are afoot to restructure the pension system with assistance from the World Bank and the government is putting in place a strong institutional framework for Public Private Partnerships. Egypt successfully issued its first international local-currency bond (LE 6 billion), seeking to widen the investor pool, foster secondary trading and hence establish a meaningful benchmark yield curve.
Recent steps undertaken to facilitate business activities include slashing the time, fees, and minimum capital required to set up a business; drastically lowering fees for registering property; and cutting further the time needed for imports and exports to clear customs.
Egypt's macroeconomic vulnerabilities seem low. The diversified sources of foreign capital (mostly from Europe, the countries of the Gulf Cooperation Council and North America) and a still-low share of speculative funds limit the risk of a sudden reversal of capital flows. The vulnerability to any reversal is furthermore limited as little of these inflows have been intermediated through the banking system and the Central Bank of Egypt's international reserves are high. Stress testing conducted during the recent joint World Bank/IMF Financial Sector Assessment Program (FSAP) Update highlights that the banking system would be vulnerable mainly to a deterioration of domestic credit quality and much less to exchange and interest rate movements. To date Egypt has weathered the recent turbulences in global financial markets rather well, some pullback in the stock and fixed-income markets notwithstanding.
Executive Board Assessment
Executive Directors commended the Egyptian authorities' sound macroeconomic management and bold economic reforms. Fiscal adjustment and significant achievements in privatization and financial sector reform have increased market confidence and boosted investment, thereby helping to sustain a high pace of economic growth. Growth is increasingly broad-based, contributing to a substantial reduction in unemployment.
Looking ahead, Directors observed that important challenges remain. They pointed, in particular, to the high government budget deficit, shallow financial intermediation, and remaining bureaucratic barriers to private sector activity. Furthermore, domestic demand continues to contribute to the inflationary pressures. Directors also cautioned that the slow trickle-down of the benefits of economic growth could weaken public support for the reform effort.
Against this background, Directors welcomed the authorities' commitment to reduce the fiscal deficit to 3 percent of GDP by fiscal year 2010/11. This will help further increase investor confidence, further improve the economy's resilience to exogenous shocks, reduce the public debt, and underpin macroeconomic stability. In this context, Directors commended the fiscal adjustment achieved last year, including through the reform of tax administration and public finance management and the reduction of fuel subsidies. They welcomed the planned further reduction of fuel subsidies, and called for stronger social safety nets to protect vulnerable segments of the population, as well as more efficient and better prioritized social spending. Directors looked forward to quick progress on the value added tax reform, containment of the wage bill, and further broadening of the tax base.
Directors commended the efforts of the central bank to strengthen monetary policy formulation and improve the interest rate transmission mechanism. They generally supported the central bank's pragmatic approach of focusing on underlying inflation to forestall second-round effects of administered price increases and supply shocks. Directors cautioned that, going forward, monetary policy will need to be vigilant in light of continued demand pressures. They welcomed the planned adoption of inflation targeting, which should be introduced after steps are taken to ensure a competitive banking system and a consistent monetary policy framework.
Directors welcomed the move to greater exchange rate flexibility since mid-2007, which has enhanced the coherence of the macroeconomic policy mix. The ensuing exchange rate appreciation has helped in curbing inflation. Directors considered that allowing a greater role for market forces in determining the exchange rate would help to deal with pressures arising from capital inflows and to underpin the move to inflation targeting. They agreed that Egypt's current account is consistent with external stability, and that the exchange rate is broadly in line with economic fundamentals.
Directors commended the significant progress in financial sector reform, and welcomed the authorities' plans for further reform in line with key recommendations of the recent FSAP Update. They welcomed the successful sale of a major state-owned bank and the efforts to reduce the nonperforming loans in the banking system. They encouraged completion of the privatization of another bank in 2008 as planned. Directors emphasized the importance of improving supervision, completing bank recapitalization, enhancing the monitoring of state banks, and undertaking complementary regulatory and judicial reforms. Some Directors called for gradual privatization of the large state-owned insurance company, in line with the authorities' overall thrust toward greater private sector participation in the financial sector.
Directors stressed that enhancing the investment climate will be crucial to sustain the growth momentum. They welcomed the ongoing efforts to reduce barriers to private sector activity, including through lower import tariffs, reduction of red tape, and a strengthened legal framework for business activities. They also pointed out that a faster pace of job creation will require labor market reforms and education to reduce skill mismatches, non-wage costs, and constraints on hiring and firing.