## _cr1533 ## Source details **Canonical URL:** [_cr1533](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1533.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1533.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1533.pdf.json) --- ### Growth diagnostic and binding constraints - Political context: momentous political change since January 2011; continued political and security risks affecting confidence, investment, and tourism. - Growth performance: - GDP growth: dropped by 0.8 percent in calendar year 2011; about 2 percent annually thereafter; 2.2 percent in 2013/14; rebounded to 6.8 percent y-o-y in Q3 2014. - 2004–10 average growth: 5½ percent annually. - Labor and social indicators: - Unemployment: peaked at 13.4 percent in 2013/14; 13.1 percent in Q3 2014. - Poverty: rose to 26.3 percent in 2012/13; another 20 percent estimated close to the poverty line. - Inflation: - Average inflation: 10.1 percent in 2013/14. - Headline spike: 11.8 percent in October (post-July 2014 adjustments); receded to 10.1 percent in December. - Core inflation: 7.7 percent. - Binding constraints to growth and job creation: - Macroeconomic risks: fiscal and external vulnerabilities undermine confidence and investment. - Microeconomic distortions: high untargeted subsidies (notably energy), weak governance and contract enforcement, large public sector presence (public sector generated 39 percent of formal GDP in 2013/14). - Low human capital and infrastructure deficits: poor health and education indicators; electricity, fuel, water shortages; distribution bottlenecks. - Low access to finance: declining credit to private sector as share of GDP; low bank penetration; very low credit to SMEs. - Poor external competitiveness: nonoil merchandise exports 4.8 percent of GDP in 2013/14; real exchange rate appreciation. ### Underlying current account and external financing - Recent developments: - Tourism receipts dropped by 50 percent in 2013/14; current account balance widened to 5 percent of GDP (excluding grants). - Nonoil exports below 5 percent of GDP in 2013/14. - Net FDI remained flat; external financing gaps covered by some $20 billion in Gulf aid. - Reserves: $14.9 billion at end-December 2014 (2½ months of imports). - Exchange rate and FX market: - Official exchange rate broadly unchanged since June 2013, supported by Gulf support. - Pound depreciated by 13 percent in six months after CBE’s December 2012 auctions; since June 2013 official rate depreciated by less than 2 percent against the U.S. dollar. - Real effective exchange rate appreciated by 18 percent at end-November 2014. - Parallel market premium: fluctuated between 2–7 percent. - Staff projections and outlook: - Authorities’ medium-term targets by 2018/19: 6 percent GDP growth and 7 percent inflation; budget deficit reduced to 8–8½ percent of GDP; budget sector debt down to 80–85 percent of GDP. - Staff projections with consistent policy: actual and potential growth could reach 5 percent by 2018/19; unemployment could fall to 10 percent; short-term growth 3.8 percent this fiscal year. - External financing gaps projected about $36 billion through 2018/19 (about $7 billion per year on average); about half used to build reserves to 3½ months of imports. - Current account deficit projected to remain around 3½–4½ percent of GDP. ### Fiscal outlook, consolidation plans, and risks - Recent fiscal picture: - 2013/14 budget sector deficit: 13.8 percent of GDP despite large external grants. - Grants from Gulf countries: 3.8 percent of GDP in 2013/14. - Budget sector debt rose to 95.5 percent of GDP; general government debt to 90.5 percent of GDP. - 2014/15 budget target: deficit of 10 percent of GDP (including grants equivalent to 1 percent of GDP). - Measures in 2014/15 expected savings: 2½ percent of GDP; additional measures (VAT, telecom license sale, mining law) expected to yield about 1 percent of GDP later in fiscal year. - Staff estimate and risks: - Staff estimates 2014/15 budget deficit likely about 11 percent of GDP. - Pending legislation/actions relevant to 2014/15: VAT law, mining taxation law, sale of an additional telecom license (yielding about 1 percent of GDP) remain to be passed. - SOE risks: EGPC tax arrears last year of 1–1¾ percent of GDP. - Policy priorities to reach targets: - Step up subsidy reform by raising energy prices again. - Ensure a well-functioning VAT is in place. - Identify spending cuts to offset planned increases in health and education spending. - Keep expenditure in check to reduce budget deficit as targeted. - Timing: - With steadfast implementation, deficit objective can be met by 2016/17 and debt objective three years later (general government debt falls below 80 percent of GDP already in 2018/19). - Contingency measures suggested: - Further control public sector wage growth and hiring. - Set a higher VAT rate or raise it over time. - Strengthen property taxation. - Strengthen governance of SOEs to mitigate fiscal risks. ### Energy subsidy reform (Box 2) - Historical cost: - Untargeted energy subsidies budgetary cost over 6 percent of GDP in 2013/14. - July 2014 price increases and impact: - Prices increased by 64 percent for diesel, 78 percent for Octane 80 gasoline, and 41 percent for Octane 92 gasoline. - Implemented increases expected budget savings close to 2 percent of GDP annually. - Authorities intend to eliminate all subsidies over next five years except LPG subsidies targeted to the poor. - Smart cards launched to monitor consumption and limit smuggling. - Distortions: - Energy subsidies diverted resources, contributed to arrears, and worsened supply shortages and fiscal deficits. - Despite subsidies, SOEs did not meet high energy demand; LPG retail prices often multiples of official price; electricity outages increased. - Distributional note: - Benefits of untargeted subsidies accrue mostly to high-income households; direct effect of July price increases for gasoline and diesel is mildly progressive. ### Debt dynamics and stress tests - Key stress-test findings: - A one standard deviation fall in growth from baseline would drive debt up to almost 95 percent of GDP. - Combination of main macro-fiscal shocks could drive debt to almost 100 percent of GDP within two years. - Baseline public debt projections (percent of GDP): - 2012: 85.6; 2013: 78.9; 2014: 89.0; 2015: 90.1; 2016: 90.3; 2017: 86.9; 2018: 84.1; 2019: 80.9. - Baseline macro assumptions (selected): - Real GDP growth: 2014: 2.2; 2015: 3.8; 2016: 4.3; 2017: 4.5; 2018: 4.7; 2019: 5.0. - Inflation (GDP deflator): 2014: 11.5; 2015: 10.7; 2016: 10.0; 2017: 9.6; 2018: 9.2; 2019: 7.4. - Primary balance: 2014: -6.1; 2015: -3.6; 2016: -1.4; 2017: -0.7; 2018: -0.6; 2019: -0.5. - Effective interest rate: 2014: 7.9; 2015: 10.6; 2016: 12.2; 2017: 10.8; 2018: 10.9; 2019: 11.2. - External debt specifics: - External debt stock end-2013/2014: $46.1 billion (16.1 percent of GDP). - About 92 percent medium- to long-term; 99 percent owed to official creditors. - 2014/15 support expected mostly from the UAE in form of loans, increasing external debt stock. - External debt projected to remain about 16–17½ percent of GDP medium term. - Stress-test sensitivities: - A 30 percent real exchange rate depreciation in 2014 would lead to a 10 percentage point increase in external debt-to-GDP ratio in 2019 versus baseline (static). - A current account shock raises external debt-to-GDP by 5 percentage points versus baseline. - Growth and real interest rate developments are main vulnerabilities for public debt dynamics. ### External sector assessment and exchange rate policy - REER and competitiveness: - REER appreciated by 11 percent since end-2010 (as of October 2014); current REER about 28 percent above 15-year average and 29 percent above 10-year average. - IMF overvaluation estimate range: 3–28 percent. - Real appreciation about 18 percent between June 2013 and November 2014 noted elsewhere. - Reserves adequacy: - End-December 2014 reserves: 2½ months of imports (40 percent of standard reserve adequacy metric for fixed regimes). - Staff recommends target reserves equivalent to 4½ months of imports to align with IMF reserve adequacy metric for flexible regimes. - Policy implications: - Staff favors greater exchange rate flexibility and removal of restrictions in FX auctions and interbank markets to allow market-clearing rates and eliminate parallel market premium. - Introduce macroeconomic and structural reforms to restore investor confidence and boost competitiveness. - Recognize uncertainty in GCC financing beyond 2014/15 and plan for risks to external financing if oil prices decline. - Current account norm and projections: - Current account norm estimated at about -2.5 percent of GDP. - Current account excluding grants rose to 5 percent of GDP last year; staff projects current account deficit around 3½–4½ percent of GDP medium term. ### Monetary policy and banking sector soundness - Monetary stance and actions: - CBE allowed continuous use of government overdraft; CBE net credit to government increased to 24.1 percent of GDP in November 2014 (against 18 percent in June 2013). - CBE raised policy rates by 100 bps in July 2014; cut benchmark rate by 50 bps on January 15, 2015. - Staff stresses need for strong, independent monetary policy to lower inflation and support competitiveness. - Banking-sector indicators (selected exact values preserved): - Regulatory capital to risk-weighted assets: FY2011 2/15.9; FY2012 14.9; FY2013 13.7; Jun. 2014 13.0. - Nonperforming loans to total loans: FY2011 10.5; FY2012 9.8; FY2013 9.3; Jun. 2014 9.1. - Provisioning coverage: loan provisions to NPLs: FY2011 94.5; FY2012 97.1; FY2013 99.8; Jun. 2014 98.0. - Return on assets: FY2011 0.8; FY2012 1.0; FY2013 1.0; Jun. 2014 1.0. - Liquidity ratio: local currency: FY2011 55.6; FY2012 58.4; FY2013 61.8; Jun. 2014 62.9. - Loans to deposits: FY2011 50.2; FY2012 48.1; FY2013 44.1; Jun. 2014 41.1. - System assessment: - System-wide NPLs declined from 10.5 percent in 2011 to 9.1 percent in June 2014; provisioning coverage 98 percent. - Banks hold high-yielding government debt exposures; private-sector credit remains limited. - CBE completing Pillar 2 of Basel II and on track to implement Basel III; macro-prudential framework strengthened with regular stress testing. ### Policy recommendations and strategic priorities (Staff appraisal) - Overarching judgment: adjustment and reform, if resolutely followed, will lead to economic stability and growth; fuel subsidy reform is transformative. - Three strategic strands: 1. Unlock private sector-led growth via regulatory reform, competition, and financial sector development. 2. Investment to repair infrastructure with priority on energy sector reforms; prioritize projects that create short-term jobs and raise potential growth and exports; involve private sector and monitor contingent liabilities. 3. Protection of the poor via cash transfer scheme, reform of food ration cards, improved targeting, and increased education and health spending if managed wisely. - Immediate fiscal priorities: - Enact a modern VAT with rate and coverage consistent with fiscal targets. - Implement second stage of subsidy reforms. - Continue tax reform and wage/spending controls to restore debt sustainability and allow CBE to anchor inflation into single digits. - Exchange rate and external policy: - Move toward greater exchange rate flexibility to avoid excessive real appreciation and improve foreign exchange availability, competitiveness, and FDI attraction. - Build reserves and contingency plans; be ready for further adjustment or additional external financing if adverse shocks materialize. - Social protection: - Strengthen and expand cash transfers and targeted social programs; planned pilots: unconditional benefit for elderly/disabled and conditional transfers piloted on 600,000 families, expected to cover 1.5 million households once rolled out. - Bread subsidies streamlined; food ration cards reformed. ### Megaprojects (Appendix I) - Authorities’ strategy emphasizes increasing domestic investment and complementary business climate improvements. - Preliminary megaprojects list (selected): - Suez Canal Regional Development project (parallel canal by mid-2015; second-stage services development). - Building one million houses around greater Cairo. - Construction and rehabilitation of 3,000 km of new roads. - Reclamation of one million acres of land. - Renewable energy projects. - “Golden Triangle” natural resources and development project. - Suez Canal project financing (first stage, September 2014): - SCA issued LE64 billion non-tradable investment certificates (about $9 billion), maturity five years, interest 12 percent. - Fiscal impact: interest and principal paid by SCA reduce budget revenues by about $13 billion over five years through lower corporate income taxes and dividends. - Fiscal risks: - Megaprojects could generate contingent liabilities; only Suez Canal project explicitly included in staff’s fiscal projections. ### Selected headline macroeconomic indicators and projections (select latest projection year 2015/16) - Real GDP (market prices): 4.3 - CPI inflation (end of period): 10.5 percent; (period average) 10.1 percent - Overall balance (general government, IMF staff definition): -8.5 percent of GDP - Gross Debt (general government): 87.1 percent of GDP (External: 12.2; Domestic: 74.9) - Current account (percent of GDP): -4.3 - Gross international reserves: 21.2 (in billions of US$) — In months of next year's imports: 3.2 - Nominal GDP (in billions of Egyptian pounds): 2,631.3 - Unemployment rate (period average): 12.7 percent - Population: 90.2 (millions) ### Balance of payments (select 2015/16 figures) - Current account: -15.4 (in billions of US$) - Balance on goods and services (2015/16): -30.2 (in billions of US$) - Exports of goods and services: 42.6 (in billions of US$) - Imports of goods and services: -72.7 (in billions of US$) - Tourism receipts: 8.0 (in billions of US$) - Suez canal receipts: 6.1 (in billions of US$) - Transfers: 20.2 (in billions of US$) - Foreign direct investment (net): 6.9 (in billions of US$) - Gross international reserves (end of period): 21.2 (in billions of US$) - Overall balance (2015/16): -4.1 (in billions of US$) ### Key risks and contingency guidance - Downside risks: - Vulnerability to global, regional, and domestic shocks given fragile reserves. - Slower global growth, abrupt financial volatility, reduced external inflows (official support, FDI, tourism). - Intensification of regional conflicts or deterioration in domestic security or rule of law. - Policy delays that could derail fiscal consolidation. - Risk mitigation and contingency measures: - Strengthen macroeconomic policies, build buffers, prepare contingency budget measures. - Possible contingency fiscal measures: further wage and hiring controls, higher VAT rate, strengthen property taxes, improve SOE governance. - Upside opportunities: - Successful reform implementation and political roadmap completion could rapidly boost confidence, growth, job creation, and capital inflows. - Recovery in tourism, FDI, and sectors: energy, manufacturing, mining, construction, telecom. *Source: _cr1533 (IMF staff report excerpts)._ ### 1. Growth Diagnostic and Constraints to Growth _________________________________________________5 ### 1. Growth Diagnostic and Constraints to Growth ### Context - Egypt experienced momentous political change beginning January 2011, with a change of government in July 2013, a new constitution in January 2014, and a presidential election in May 2014. Parliamentary elections were scheduled for March-April 2015. - Underlying political and social tensions continued, including deadly protests and ongoing terrorist attacks. - Political instability over the past four years reduced confidence, economic activity, investment, and tourism, causing collapsing fiscal revenue and foreign exchange earnings while expenditure rose. - The authorities are pursuing inclusive growth and job creation through structural reforms, promoting investment, protecting the poor, fiscal adjustment, and tight monetary policy to contain inflation. ### Recent economic developments — overview and key figures - Growth: - GDP growth: dropped by 0.8 percent in calendar year 2011; recovered to about 2 percent annually in subsequent years; GDP grew by 2.2 percent in 2013/14; growth rebounded to 6.8 percent y-o-y in Q3 2014. - Growth patterns: 2004–10 average growth was 5½ percent annually; 2011–2014 period shows a slowdown. - Contributions to growth (2004–10 vs 2011–2014): growth driven mainly by consumption; investment lagged; external sector contributed negatively. - Labor market and social: - Unemployment: peaked at 13.4 percent in 2013/14; 13.1 percent in Q3 of 2014. - Poverty: rose to 26.3 percent in 2012/13; another 20 percent estimated close to the poverty line. - Inflation: - Average inflation: 10.1 percent in 2013/14. - Inflation spikes: reached 11.8 percent in October (after July 2014 fuel and tobacco hikes and higher school fees); headline inflation receded to 10.1 percent in December. - Core inflation: 7.7 percent. - Fiscal sector: - 2013/14 budget sector deficit widened to 13.8 percent of GDP, despite large external grants. - Grants from Gulf countries accounted for 3.8 percent of GDP in 2013/14. - Budget sector debt rose to 95.5 percent of GDP; general government debt rose to 90.5 percent of GDP. - The 2014/15 budget targeted a deficit of 10 percent of GDP (including grants equivalent to 1 percent of GDP). - Measures implemented in 2014/15 expected to yield savings of 2½ percent of GDP; additional VAT, telecom license sale, and mining law expected to yield about 1 percent of GDP later in the fiscal year. - External sector and reserves: - International reserves fell from $35 billion (6.8 months of imports) at end-2010 to $14.5 billion (2.5 months) in June 2013. - Central Bank of Egypt supplied large amounts of foreign currency to stabilize exchange rate, supported by sizable official financing from Gulf countries at times. - Monetary and financial: - Broad money growth accelerated in 2012/13, driven mainly by government financing needs. - Banks and the central bank accumulated large claims on government. - Government borrowing crowded out private sector credit; credit to private sector declined as share of GDP over the past decade. - Interest rates came down from post-2011 highs; stock market recovered over the past year and a half. ### Growth diagnostic — binding constraints (Box 1) Staff analysis identifies the most binding constraints to growth and job creation in Egypt as: - Macroeconomic risks - Fiscal and external vulnerabilities undermine confidence and investment. - Microeconomic distortions - High subsidies (notably energy subsidies) create bias toward capital- and energy-intensive industries, divert resources and FDI away from more efficient or labor-intensive sectors. - Inefficient labor markets push activity into the informal sector. - Weak governance, perceived corruption, poor enforcement of contracts, an unpredictable judicial system, and constraints to doing business. - Large public sector presence: public sector generated 39 percent of formal GDP in 2013/14; public institutions control majority of assets in banking and insurance, are important in telecom and transportation, and dominant in oil and gas, refining, and electricity. Anecdotal evidence of significant military control over some public enterprises and land. - Low human capital and poor infrastructure - Poor health and education indicators; education underfunded and not aligned to productive employment. - Infrastructure deficits in roads and electricity, traffic congestion, distribution bottlenecks, and shortages of electricity, fuel, and water. - Low access to finance - Declining credit to private sector as share of GDP over the past decade. - Crowding out from public sector borrowing raises interest rates and reduces incentives to lend to private sector. - Low bank penetration, low bank deposits, and very low credit to SMEs. - Poor external competitiveness - Nonoil merchandise exports were 4.8 percent of GDP in 2013/14. - Limited external linkages, real exchange rate appreciation, and unfavorable business environment. ### Transmission of political turmoil into economic outcomes - Post-2011 developments: - Sharp capital account reversal, capital outflows, declining investment and tourism. - Real GDP contraction in 2011, depressed growth thereafter, and energy shortages/electricity blackouts disrupted production. - Double-digit budget deficits nearing 14 percent of GDP in 2012/13 due to delayed reforms, lower revenue, and rising wage, subsidy, and interest payments. - Exchange rate pressures in late 2012 and first half 2013, with reserves supported by official financing and foreign exchange rationing that compressed imports and generated a parallel market. - Social outcomes worsened: unemployment and poverty increased. - By June 2013: low growth, high unemployment, wide fiscal and external imbalances, and low reserves buffers. ### Policy actions and reform priorities highlighted - Fiscal consolidation and revenue measures implemented in 2014/15 budget: - Energy subsidy reforms: price hikes for fuel products by 40–80 percent and electricity by 20 percent implemented at outset of fiscal year. - Tax measures: introduction of taxes on dividends and capital gains; a 5 percent additional tax on high incomes; increases in excises on tobacco and alcohol; a revamped property tax. - Planned measures later in fiscal year: introduction of a fully fledged value-added tax (VAT) conforming to international standards to replace the sales tax; sale of a telecom license; adoption of a new mining law. - Monetary policy: - Tight monetary policy to contain inflation while supporting fiscal consolidation. - Structural reforms: - Pursue reforms to improve business climate, labor market efficiency, financial market development, education, and governance to address microeconomic distortions, low productivity, and poor competitiveness. - Social protection: - Protect the poor while implementing subsidy reforms and fiscal consolidation. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1533.pdf* ### 11. The underlying current account deficit ### 11. The underlying current account deficit ### Underlying current account developments - Tourism receipts dropped by 50 percent in 2013/14, widening the current account balance to 5 percent of GDP (excluding grants). - Nonoil exports dropped below 5 percent of GDP in 2013/14. - Net FDI remained flat as political and judicial uncertainty (including court cases reversing past privatization deals) affected the investment climate. - External financing gaps were covered by some $20 billion in Gulf aid (grants, deposits, and oil shipments). - Reserves were $14.9 billion at end-December 2014 (2½ months of imports). ### Exchange rate and foreign exchange market - The official exchange rate has remained broadly unchanged since June 2013, supported by large Gulf-country support. - The pound depreciated by 13 percent in the six months following the introduction of the CBE’s tightly managed foreign exchange auctions in December 2012. - Since June 2013 the official rate depreciated by less than 2 percent against the U.S. dollar. - The real effective exchange rate appreciated by 18 percent at end-November 2014, driven by high inflation differentials with trading partners and the appreciation of the dollar against other major currencies. - Restrictions in the auctions and on the interbank market prevented a market-clearing adjustment. - Parallel market premium fluctuated between 2–7 percent. - Backlogs of foreign exchange requests from commercial banks were only partially cleared through occasional large auctions. - In December 2014, the CBE increased the weekly auctioned amounts by 25 percent. ### Monetary policy, credit, and banking sector soundness - The monetary stance remained broadly accommodative as the central bank accommodated the government’s financing needs by allowing continuous use of the government overdraft facility. - The CBE’s net credit to the government increased to 24.1 percent of GDP in November 2014 (against 18 percent in June 2013). - The CBE raised its policy rates by 100 bps in July 2014 to preempt second-round effects of regulated price hikes. - Credit to the economy grew at 8.5 percent in 2013/14 and fell in real terms. - High nominal interest rates discouraged credit demand; compressed differentials between lending rates and earnings on government securities reduced banks’ incentives to lend to the private sector. - Banking-sector indicators (Central Bank of Egypt source): - Regulatory capital to risk-weighted assets: FY2011 2/15.9; FY2012 14.9; FY2013 13.7; Jun. 2014 13.0 - Net worth to assets: FY2011 6.8; FY2012 7.2; FY2013 7.1; Jun. 2014 6.9 - Nonperforming loans to total loans: FY2011 10.5; FY2012 9.8; FY2013 9.3; Jun. 2014 9.1 - Loan provisions to nonperforming loans: FY2011 94.5; FY2012 97.1; FY2013 99.8; Jun. 2014 98.0 - Return on assets: FY2011 0.8; FY2012 1.0; FY2013 1.0; Jun. 2014 1.0 - Return on equity: FY2011 11.7; FY2012 13.9; FY2013 14.5; Jun. 2014 14.5 - Liquidity ratio: local currency: FY2011 55.6; FY2012 58.4; FY2013 61.8; Jun. 2014 62.9 - Liquidity ratio: foreign currency: FY2011 51.8; FY2012 56.3; FY2013 55.2; Jun. 2014 61.2 - Loans to deposits: FY2011 50.2; FY2012 48.1; FY2013 44.1; Jun. 2014 41.1 - System-wide NPLs declined from 10.5 percent in 2011 to 9.1 percent in June 2014, with provisioning coverage reaching 98 percent. - Forbearance measures for the tourism sector had limited impact given the small share of such loans. - Stress tests performed by the CBE suggest plausible losses could be absorbed by banks’ profits and capital buffers; exchange rate exposure is not significant. - Despite ample domestic currency liquidity, limited availability of foreign exchange generates sizable backlogs for bank customers. ### Data provision - Government finance, monetary, and external sector statistics are adequate for surveillance, and transparency and dissemination have improved recently. - Only aggregate banking data are available, and data on general government are available only with a lag. ### Outlook and risks - Authorities’ targets by 2018/19: 6 percent GDP growth and 7 percent inflation, a budget deficit reduced to 8–8½ percent of GDP and a budget sector debt down to 80–85 percent of GDP. - Staff projections with consistent policy implementation: - Actual and potential growth could reach 5 percent by 2018/19. - Unemployment could fall to 10 percent if reforms raise investment and productivity. - Short-term growth expected to pick up to 3.8 percent this fiscal year. - Trade and current account deficits are expected to remain elevated due to high domestic demand and limited competitiveness; external financing gaps are expected to persist with only a limited buildup of reserves to 3½ months of imports. - Lower global oil prices are expected to improve overall prospects by reducing the net cost of energy in the balance of payments and significantly reducing the fiscal cost of fuel subsidies; staff projections reflect the January 2015 World Economic Outlook projections. - Downside risks: - High vulnerability to global, regional, and domestic shocks given fragile external reserves. - Slower growth in advanced and emerging economies or abrupt global financial market volatility could reduce external inflows including official support, FDI, and tourism. - A slowdown in global trade could affect Suez Canal revenues. - Intensification of regional conflicts or deterioration in domestic security or perceived departures from the rule of law could affect confidence, investment, and tourism. - Policy delays could derail fiscal consolidation and widen imbalances. - Risk mitigation: strengthen macroeconomic policies, prepare contingency measures, build buffers; in adverse developments further fiscal adjustment, greater exchange rate depreciation and additional external financing may be needed. - Upside opportunities: - Successful reform implementation and completion of the political roadmap could boost confidence, restore macroeconomic stability more rapidly, and lead to higher growth, job creation, and capital inflows. - Faster recoveries in tourism and FDI, especially if the March 2015 investor conference is successful. - Sectors with upside potential: energy, manufacturing, mining, construction, and telecom. - Internal market reforms could reduce supply bottlenecks and benefit inflation. ### Policy discussions and reform priorities - Restoring macroeconomic stability is a prerequisite for growth; authorities have started addressing the fiscal deficit through actions on subsidies, wages, and taxes, and intend to pursue further measures. - The CBE raised policy rates to anchor inflation expectations and intends to pursue tight monetary policy as needed. - External sustainability to be achieved by improving competitiveness, lowering inflation, and increasing exchange rate flexibility; staff emphasizes exchange rate flexibility more than authorities. - A. Strategy for inclusive growth - Structural reforms and investment are needed to unlock growth potential and generate jobs. - Authorities prioritize improving the business climate through an ambitious overhaul of the regulatory framework, including amendments to the competition law and major revisions to investment, bankruptcy, corporate laws, and regulations pertaining to access to land. - Settlements with local and foreign investors are being advanced; reforms on public sector pay and hiring practices are in progress. - Financial sector development and inclusion - Authorities are revising regulatory and supervisory frameworks to support mortgage finance (central bank subsidizing bank lending to low and middle-income borrowers through a fund equivalent to 0.9 percent of GDP). - Plans to modernize capital markets and upgrade insurance framework. - Enhancing the secondary market for government securities to develop the yield curve. - New microfinance law expected to support access to finance; efforts to develop mobile payments to increase banks’ customer base. - Promoting investment - Increasing investment is a priority; public spending on health, education, and scientific research mandated by the new constitution can improve human and physical capital if accompanied by service delivery reforms. - Investment in infrastructure is needed but caution warranted given high public debt. - The March 2015 conference is an opportunity to raise private investment through FDI and PPPs; authorities intend to structure PPPs to minimize direct and contingent liabilities. - Megaprojects - Suez Canal flagship project and other planned megaprojects (housing, land reclamation, energy, roads, infrastructure) have potential to generate jobs and growth but carry fiscal risks if they entail additional public investment, large contingent liabilities, or lower budget revenues. - Staff notes only the Suez Canal project is explicitly included in staff’s fiscal projections; other projects are too early for clear fiscal implications. - Staff welcomed that tax exemptions were not being considered for the projects. - Energy sector - Renewed investment and reforms in the energy sector are critical to reduce supply bottlenecks and raise potential growth. - Government efforts to settle some $6 billion in arrears to foreign companies will help. - Implemented and planned increases in fuel and electricity prices give some confidence new arrears will not be incurred. - Interest in private investment in oil, gas, and electricity is reported, but investor willingness may be reduced by recent falls in the oil price. - Encouraging prospects for renewable energy investment (solar and wind). - Social protection and employment - Social solidarity pension system covers 1.5 million households. - Two cash transfer schemes launched: an unconditional benefit for the elderly and disabled, and a conditional transfer for families to support children’s health and education in poor areas; piloted on 600,000 families in Upper Egypt and expected to cover 1.5 million households once fully rolled out. - Bread subsidies streamlined and food ration cards reformed to allow greater flexibility and reduce leakages. - Improvements planned for agricultural services, grain storage, and farmers’ access to finance. - Planned increases in education and health spending to be partly financed by savings from subsidy reforms. - Employment prospects to improve with higher growth, structural reforms, education spending focused on closing jobs-skills mismatch, and public service pay reforms. - B. Reducing the fiscal deficit — key measures - Government objectives: reduce the budget deficit to 8–8½ percent of GDP and budget sector debt to 80–85 percent of GDP while increasing spending on health, education, and scientific research. - Key reform measures: - Subsidy reform: following the July 2014 increase, the government intends to continue raising fuel and electricity prices over the next 4–5 years. At the time, the plan would have required fuel prices to rise by about 20 percent every year to reach close to cost recovery by 2018/19. At current global oil prices, phasing out subsidies could be achieved sooner or with lower annual price increases. A new system of smart cards has been launched to monitor wholesale and retail sales and combat smuggling. - Containing the wage bill: ceiling for public sector wages set; bonuses subjected to income taxes and discontinued from automatic inclusion in basic wages after five years; new hires centralized and require approval by the finance ministry; use of public entities’ own resources for additional employee rewards discontinued; authorities working on a thorough revision of the public pay system and an attrition scheme limiting the number of retirees to be replaced. - Other spending: reprioritization expected to reduce non-priority capital spending by about 1 percent of GDP while increasing health and education investment by about the same amount; stabilize purchases of goods and services after their substantial decline. Non-priority spending to be cut has in most cases not yet been identified. - VAT reform: government plans to replace the current sales tax with a fully fledged VAT in the spring of 2015. A draft law following international standards has been prepared and the tax administration is finalizing preparatory steps. Work is underway to develop a simplified tax regime for SMEs alongside the new VAT, and to improve tax compliance and control systems. *Source: _cr1533 - 11. The underlying current account deficit* ### 32. Staff and the authorities agreed that these plans could achieve the targeted deficit and ### _cr1533 - 32. Staff and the authorities agreed that these plans could achieve the targeted deficit and ### Fiscal outlook and risks - Staff estimates the budget deficit for 2014/15 will likely reach about 11 percent of GDP. - Potential upside and downside risks to the 2014/15 projection: - Pending legislation/actions: the VAT law, the mining taxation law, and the sale of an additional telecom license (yielding about 1 percent of GDP) remain to be passed. - Some elements (including the VAT rate) are still being finalized and need to be consistent with the authorities’ revenue goals. - Risks related to SOE performance, illustrated by a buildup of EGPC tax arrears last year of 1–1¾ percent of GDP. - Policy priorities for 2015/16 and beyond to achieve deficit and debt targets: - Step up subsidy reform by raising energy prices again. - Ensure a well-functioning VAT is in place. - Identify spending cuts to offset planned increases in health and education spending. - Keep expenditure in check to reduce the budget deficit as targeted. - Timing of targets: - With steadfast implementation, the authorities’ deficit objective can be met by 2016/17 and their debt objective three years later (although general government debt will fall below 80 percent of GDP already in 2018/19). ### Contingency measures and fiscal governance - Authorities should be prepared to take contingency measures if adverse shocks occur or expected savings are not fully achieved. Possible measures include: - Further steps to control public sector wage growth and hiring. - Setting a higher VAT rate than currently envisaged, or raising it over time. - Further strengthening property taxation. - Strengthening governance of SOEs to mitigate fiscal risks. ### Box 2 — Energy Subsidy Reform (summary of findings and strategy) - Historical cost: - Budgetary cost of untargeted energy subsidies reached over 6 percent of GDP in 2013/14. - Distortions and consequences: - EGPC receives free crude oil and natural gas as part of production-sharing contracts; excess costs when international prices exceeded budget assumptions were borne by EGPC, affecting financial performance and resulting in large arrears to foreign partners and suppliers. - Price distortions contributed to a worsening energy crisis, large budget deficits, and weighed on growth. - Negative feedback to FDI in the energy sector through diversion of production to satisfy the domestic market, leading to external arrears and reduced investment in new exploration. - Despite large subsidies, SOEs in the energy sector have generally not met high energy demand; retail LPG prices have often been multiples of official price; electricity outages increased. - Authorities’ reform plan: - Intend to eliminate all subsidies over the next five years, except LPG subsidies targeted to the poor. - In July 2014, prices were substantially increased for households and commercial uses, with expected budget savings of close to 2 percent of GDP annually. - Strategy includes rolling out smart cards to monitor consumption and limit smuggling. - Notable numeric price increases in July 2014: - Prices increased by 64 percent for diesel, 78 percent for Octane 80 gasoline, and 41 percent for Octane 92 gasoline. - Distributional note: - Benefits of untargeted subsidies accrue mostly to high-income households; direct effect of July price increases for gasoline and diesel is mildly progressive. ### Ambition and calibration of fiscal consolidation - Planned consolidation is described as very substantial: - Among cases in emerging and developing countries, 65 percent saw a change in the cyclically adjusted primary balance of less than 5.8 percentage points of GDP (the planned adjustment in Egypt over the next five years). - Even with adjustment: - General government debt will remain high at the end of the projection period but on a clear declining path. - Government will still need substantial credit from the banking sector, limiting scope for increases in private sector credit. ### External position and financing needs - Staff projects financing gaps reaching about $36 billion through 2018/19 (or about $7 billion per year on average). - About half of this will be used to build up reserves to 3½ months of imports (the authorities’ medium-term target). - External debt projection: - External debt would remain low in the medium term at about 17 percent of GDP. - Current account outlook: - Rebound in tourism, sustained remittance inflows, and additional Suez Canal revenue expected to support the current account. - Rising FDI and portfolio investment should provide external financing. - Trade balance deficit expected to persist; growth of non-oil exports will be insufficient to cover imports. - Current account deficit projected to remain around 3½–4½ percent of GDP. - Authorities’ view: - Authorities believe the current account deficit will not exceed 3 percent of GDP due to stronger prospects (notably tourism) and higher FDI inflows. ### Reserves and exchange rate policy - Staff recommendation on reserves: - Target reserves equivalent to 4½ months of imports to align with IMF reserve adequacy metric for flexible exchange rate regimes. - Reserve equivalence note: 4½ months of imports translates to reserve coverage of 77 percent of the standard reserve adequacy metrics under a fixed exchange rate regime and 139 percent under a flexible exchange rate regime; the latter falls within the 100–150 percent range considered adequate. - Authorities’ plan: - Currently planning to build reserves to 3½ months of imports; may consider higher targets if balance of payments developments are more favorable. - Exchange rate flexibility: - Staff favors greater exchange rate flexibility to avoid excessive real appreciation and allow the real exchange rate to move with fundamentals; recommends removing restrictions in foreign exchange auctions and markets to eliminate parallel market premium and allow market-clearing rates. - CBE agrees more flexibility is desirable in the future but stresses need for orderly foreign exchange market and appropriate timing; emphasizes improving availability of foreign exchange through formal channels. - Recent estimated real appreciation: about 18 percent between June 2013 and November 2014. - Estimated overvaluation range: between 3 and 28 percent. - Current account norm estimated at about -2.5 percent of GDP. ### Monetary policy, inflation, and banking sector - Monetary policy stance: - Agreement on need for strong, independent monetary policy; lower inflation seen as critical to support competitiveness, protect the poor, and foster growth. - Staff supports CBE’s inflation objectives and its willingness to tighten policy as needed. - Fiscal consolidation will help lower inflation by containing domestic demand, but VAT and fuel price increases will push up prices and may require further policy rate increases to contain second-round effects. - Banking sector soundness: - Banking system resilient: profitability remains high, NPLs are low, and domestic liquidity is ample, but private sector credit is low. - Banks invested in high-yielding, zero-risk weighted government debt; high sovereign exposure increases importance of public debt sustainability. - Most lending is in domestic currency; stable funding through deposits mitigates risks. - High credit concentration in loan portfolios could be a risk; prudential regulations limit exposure sizes though some limits approached or adjusted. - Regulatory developments: - CBE completing Pillar 2 of Basel II and on track to implement Basel III according to internationally agreed schedule. - Macro-prudential framework strengthened, including regular stress testing. - CBE plans to increase timeliness and scope of banking sector data disclosure and may publish regular financial stability reports. ### Article VIII and foreign exchange system assessment - Staff is assessing whether aspects of the foreign exchange system give rise to exchange restrictions or multiple currency practices under Article VIII, Section 2(a) and 3, given: - Reported backlogs in accessing foreign exchange for current international transactions. - Wide spread between official and parallel markets. - Insufficient supply of foreign exchange through the auction mechanism. - Staff is seeking information and clarifications from authorities to finalize its assessment. ### Staff appraisal — strategic priorities and recommendations - Overarching judgment: - Egypt has chosen adjustment and reform that, if followed resolutely, will lead to economic stability and growth; fuel subsidy reform cited as transformative. - Three strands of authorities’ strategy to restore growth, create jobs, and protect the poor: 1. Unlock private sector-led growth via thorough reform of the regulatory framework for businesses and investment; preserve reforms that encourage open competition; advance financial sector development as fiscal deficits recede. 2. Investment to repair infrastructure, with priority on energy sector reforms and sizable investments to reduce energy supply bottlenecks; prioritize projects that create short-term jobs and raise potential growth and exports; involve private sector and monitor projects to avoid large actual or contingent liabilities. 3. Protection of the poor via launch of a cash transfer scheme and reform of food ration cards; improve targeting and increase benefits; increase public spending on education and health if managed wisely. - Fiscal consolidation imperative: - Immediate priority: enact a modern VAT with rate and coverage consistent with fiscal targets. - Next priority: implement second stage of subsidy reforms. - Continue broader tax reform and wage/spending controls to restore debt sustainability and give the CBE space to anchor inflation into single digits. - Rebalancing and targeting of spending: - Fiscal program envisages gradual consolidation and rebalancing toward investment, education, and health financed by increased tax revenues, cuts in inefficient untargeted energy subsidies, and containment of wage bill. - Improvement in quality of public spending in social sectors is critical. - Reforms to wage-setting and hiring rules in government sector should continue. - Government should be ready to increase social transfers further to protect the poor from fiscal adjustment impacts. - External vulnerabilities and recommended policies: - Current account deficit excluding grants rose last year to five percent of GDP, above the norm. - Egypt lost half its 2011 reserves due to rising deficit and capital outflows. - Continued evidence of FX shortages: parallel market and backlog of FX demands from companies. - Policies need to address high public debt and large financing gaps via greater adjustment, financing, or both. - A more flexible exchange rate policy focused on a market-clearing rate and avoiding real appreciation would improve foreign exchange availability, strengthen competitiveness, support exports and tourism, attract FDI, foster growth and jobs, and reduce financing needs. *International Monetary Fund — Staff Report excerpt* ### 46. Egypt is also vulnerable to a deterioration of the security situation and domestic policy ### _cr1533 - 46. Egypt is also vulnerable to a deterioration of the security situation and domestic policy ### Major findings - Investor confidence depends on security and evenhanded application of the rule of law. - The authorities have made significant progress in re-establishing security: "the level of disruption of economic life is much less than in the recent past," although the country remains vulnerable to regional and indigenous terrorism. - Recent judicial decisions "have disconcerted international observers and could raise concerns among investors." - Implementation risks are significant given "the magnitude of the required adjustment." - The measures already taken by the authorities "demonstrate their commitment to reform." ### Risks and vulnerabilities - Deterioration of the security situation. - Domestic policy reversals and inconsistent application of the rule of law. - Implementation risks stemming from large-scale adjustment requirements. ### Policy implications and recommendations - Pursue the reform effort steadfastly, translating "reform objectives into coherent and consistently implemented laws." - Build financial and policy buffers to address unforeseen shocks and boost confidence. - Raise international reserves. - Prepare contingency plans for the budget in case risks materialize. *Source: _cr1533 - 46. Egypt is also vulnerable to a deterioration of the security situation and domestic policy* ### 47. It is proposed that the next Article IV consultation take place on the standard 12-month cycle. ### _cr1533 - 47. It is proposed that the next Article IV consultation take place on the standard 12-month cycle. ### Proposal - It is proposed that the next Article IV consultation take place on the standard 12-month cycle. ### Headline macroeconomic indicators (select, latest projection year in tables: 2015/16) - Real GDP (market prices): 4.3 - Consumer prices (end of period): 10.5 - Consumer prices (period average): 10.1 - Overall balance (general government, IMF staff definition): -8.5 - Overall balance, excl. grants (general government): -8.6 - Primary balance (general government): -1.4 - Gross Debt (general government): 87.1 - External: 12.2 - Domestic: 74.9 - Current account (percent of GDP, Table 1): -4.3 - Gross international reserves (in billions of US$): 21.2 - In months of next year's imports of goods and services: 3.2 - Nominal GDP (in billions of Egyptian pounds): 2,631.3 - Nominal GDP (in billions of US$): (not fully listed for 2015/16 in Table 1) - GDP per capita (in US$): (not fully listed for 2015/16 in Table 1) - Unemployment rate (period average, percent): 12.7 - Population (in millions): 90.2 ### Balance of payments (select figures, Table 2) - Current account (in billions of US$): - 2014/15: -10.8 - 2015/16: -15.4 - Balance on goods and services (2015/16): -30.2 (in billions of US$) - Exports of goods and services (2015/16): 42.6 (in billions of US$) - Imports of goods and services (2015/16): -72.7 (in billions of US$) - Tourism receipts (2015/16): 8.0 (in billions of US$) - Suez canal receipts (2015/16): 6.1 (in billions of US$) - Transfers (2015/16): 20.2 (in billions of US$) - Foreign direct investment (net, 2015/16): 6.9 (in billions of US$) - Gross international reserves (end of period, Table 2): 21.2 (in billions of US$) - Errors and omissions (net, 2015/16): 0.0 (in billions of US$) - Overall balance (2015/16): -4.1 (in billions of US$) ### Budget sector and general government (select figures) - Budget sector (Table 4, in billions of Egyptian pounds, 2015/16 projections): - Revenue and grants: 526.8 - Tax revenue: 375.4 - Nontax revenue: 163.6 - Grants: 2.2 - Expenditure: 899.9 - Wages and other remunerations: 235.0 - Interest: 243.4 - Subsidies, grants, and social benefits: 265.2 - Fuel subsidies (2015/16): 131.1 - Food subsidies (2015/16): 37.2 - Overall balance (IMF staff definition, 2015/16): -223.2 (in billions of Egyptian pounds) - Financing gap (2015/16, in billions of US$): 9.8 (mem. item) - Budget sector (Table 5, percent of GDP, 2015/16 projections): - Revenue and grants: 17.8 percent of GDP - Tax revenue: 12.5 percent of GDP - Expenditure: 29.0 percent of GDP - Overall balance (IMF staff definition): -8.5 percent of GDP - Primary balance: -0.4 percent of GDP - Gross budget sector debt (percent of GDP): 84.1 - General government (Table 6, 2015/16 projections): - Revenue and grants: 606.6 (in billions of Egyptian pounds) - Expenditure: 978.4 (in billions of Egyptian pounds) - Overall balance (IMF staff definition, 2015/16): -224.0 (in billions of Egyptian pounds) - Gross debt (percent of GDP, Table 6 mem. item): 84.1 percent ### Monetary and financial sector (select figures, Table 7) - Broad money (M2, end-period, 2015/16): 1,953.6 (in billions of Egyptian pounds) - Reserve money (mem. item): 528.2 (end-period, 2015/16) - Credit to the private sector (annual percent change, 2015/16): 14.9 - Net foreign assets (end-period, 2015/16): 142.2 (in billions of Egyptian pounds) - M2 (annual percent change, 2015/16): 17.1 ### Real economy and national accounts (select figures, Tables 8a–8b) - Real GDP growth (annual change, 2015/16): 4.3 percent - Domestic demand (absorption, 2015/16): 5.5 (annual change, percent) - Investment (2015/16): 7.6 (annual change, percent) - Exports of goods and services (2015/16, percent of GDP): 12.0 - Imports of goods and services (2015/16, percent of GDP): -18.5 - Sectoral contributions (2015/16, annual change, percent): - Agriculture: 3.2 - Construction: 19.4 - Industry: 2.4 - Services: 5.5 - CPI inflation (end-of-period, 2015/16): 10.5 percent - Unemployment rate (period average, 2015/16): 12.7 percent ### Medium-term macroeconomic framework (Table 9, select projections) - Real GDP (annual change, projections): - 2015/16: 4.3 percent - 2016/17: 4.5 percent - 2017/18: 4.7 percent - 2018/19: 5.0 percent - CPI inflation (end-of-period, projections): - 2015/16: 10.5 percent - 2016/17: 10.0 percent - 2017/18: 8.0 percent - 2018/19: 7.0 percent - Overall balance, general government (percent of GDP, projections): - 2015/16: -8.5 - 2016/17: -7.8 - 2017/18: -7.7 - 2018/19: -7.6 - Gross debt (percent of GDP, projections): - 2015/16: 87.1 - 2016/17: 84.1 - 2017/18: 81.3 - 2018/19: 79.7 - Current account (percent of GDP, projections): - 2015/16: -4.3 - 2016/17: -4.3 - 2017/18: -4.2 - 2018/19: -4.1 - Official reserves (in billions of US$, end-of-period, projections): - 2015/16: 21.2 - 2016/17: 23.8 - 2017/18: 26.4 - 2018/19: 29.7 *Source: Egyptian authorities; and IMF staff estimates and projections (content unit: _cr1533 - 47).* ### Appendix I. Megaprojects ### Appendix I. Megaprojects ### Strategy to boost growth and employment - The authorities’ strategy relies on increasing domestic investment. - Complementary measures include improving the business climate and attracting FDI. - Large infrastructure projects are being designed as part of the strategy. ### Preliminary list of possible megaprojects - (1) Suez Canal Regional Development project: - Digging of a parallel canal and the widening of the current one by mid-2015. - In a second stage, development of services around the Canal’s core activities. - (2) Building of one million houses around greater Cairo. - (3) Construction and rehabilitation of 3,000 km of new roads. - (4) Reclamation of one million acres of land. - (5) Renewable energy projects. - (6) “Golden Triangle” project to exploit natural resources in the region between Qena, Quseir and Safaga while developing the area for touristic, industrial, commercial, and agricultural activities. ### Suez Canal project — status and fiscal implications - The Suez Canal project is the most advanced and the only megaproject incorporated in staff’s projections. - Financing of the first stage (September 2014): - The Suez Canal Authority (SCA) issued LE64 billion (about $9 billion) non-tradable investment certificates. - Maturity: five years. - Interest: 12 percent. - Fiscal impact: - Interest and principal will be paid by the SCA and will therefore reduce budget revenues correspondingly through lower corporate income taxes and dividends by about $13 billion over five years. ### Feasibility, financing plans, and fiscal risks for other projects - Feasibility of other projects is still being considered; financing plans are being prepared to minimize direct and contingent liabilities for the budget. - Government involvement will be constrained by current limitations in managing a large number of public investment projects. - Risks: - Most projects are large infrastructure ventures and carry risks of generating contingent liabilities for the budget. - Project-specific financing notes: - Housing megaprojects: - Would be mostly financed through the sale of the properties and land. - Incentives for homebuyers are planned. - New roads: - Would involve mainly public funds within the planned envelope for public investment. - In some instances (i.e., toll roads) there may be involvement of private capital. - Land reclamation project: - Could benefit from support from IFIs. - Needed infrastructure will have to be financed by the budget. - Renewable energy projects (mainly solar and wind): - Should involve mainly private investors. - Government has recently adopted a “feed-in tariff” which guarantees the price of the energy produced. - Government will also guarantee the bank loans of the private investors. *Source: Appendix I. Megaprojects (content unit: _cr1533 - Appendix I. Megaprojects)* ### 4. Stress tests suggest that the main risk for the debt dynamics is related to growth and ### _cr1533 - 4. Stress tests suggest that the main risk for the debt dynamics is related to growth and ### Key findings from stress tests - A one standard deviation fall in growth compared to baseline would drive debt up to almost 95 percent of GDP. - Given the short maturity of the debt, changes in domestic real interest rates would have a significant pass-through to the budget in terms of interest expenditures and imply a persistently high debt over the medium term. - A combination of the main macro-fiscal shocks would drive the debt to almost 100 percent of GDP within two years. ### Debt profile and risk-assessment benchmarks (selected indicators, 2013) - Gross financing needs benchmark: 15% (cells highlighted relative to this benchmark in the source heat map). - Bond spread (long-term bond spread over U.S. bonds, average over the last 3 months, 13-Oct-14 through 11-Jan-15): 215 bp (listed among illustrative values 200 and 600 basis points). - External financing requirement scenarios used in stress tests: 5 and 15 percent of GDP (illustrative shock magnitudes). - Change in the share of short-term debt shocks used: 0.5 and 1 percent. - Public debt held by non-residents shock magnitudes: 15 and 45 percent. - Share of foreign-currency denominated debt shock magnitudes: 20 and 60 percent. ### Evolution and distribution of gross nominal public debt (selected percentiles and projections) - Historical and projected range percentiles shown: 10th-25th, 25th-75th, 75th-90th. - Projections display gross nominal public debt paths (in percent of GDP) with baseline and restricted/asymmetric distributions for 2012–2019. - Under stress distributions, scenarios impose restrictions: no restriction on the growth rate shock; no restriction on the interest rate shock; 0 is the max positive primary balance shock (percent GDP); no restriction on the exchange rate shock; restrictions on upside shocks. ### Realism of baseline assumptions and forecast track record (selected metrics) - Egypt median forecast error, 2005-2013: - Real GDP growth forecast error: -0.03 (Has a percentile rank of: 54%). - Primary balance forecast error (in percent of GDP): -2.65 (Has a percentile rank of: 10%). - Inflation (Deflator) forecast error: 1.57 (Has a percentile rank of: 59%). - 3-Year Adjustment in Cyclically-Adjusted Primary Balance (CAPB): distribution indicates that a 3-year CAPB adjustment greater than 3 percent of GDP is approximately top quartile. - 3-Year Average Level of CAPB: a 3-year average CAPB level greater than 3.5 percent of GDP is approximately top quartile; Egypt has a percentile rank of 7% (for adjustment) and 100% (for average level) as presented. ### Baseline public sector DSA projections (selected figures, percent of GDP unless noted) - Nominal gross public debt projections (selected years): 2012: 85.6; 2013: 78.9; 2014: 89.0; 2015: 90.1; 2016: 90.3; 2017: 86.9; 2018: 84.1; 2019: 80.9 (values shown in table header). - Public gross financing needs projections (in percent of GDP): examples shown for 2012–2019 with values in charts and tables (public gross financing needs in percent of GDP shown in projections panels). - Real GDP growth (in percent) baseline projections: 2014: 2.2; 2015: 3.8; 2016: 4.3; 2017: 4.5; 2018: 4.7; 2019: 5.0. - Inflation (GDP deflator, in percent) baseline projections: 2014: 11.5; 2015: 10.7; 2016: 10.0; 2017: 9.6; 2018: 9.2; 2019: 7.4. - Primary Balance (in percent of GDP) baseline projections: 2014: -6.1; 2015: -3.6; 2016: -1.4; 2017: -0.7; 2018: -0.6; 2019: -0.5. - Effective interest rate (in percent) baseline projections: 2014: 7.9; 2015: 10.6; 2016: 12.2; 2017: 10.8; 2018: 10.9; 2019: 11.2. ### Alternative scenarios and selected stress scenarios (exact scenario parameterizations preserved) - Constant Primary Balance Scenario: - Primary Balance held at -6.1 for 2014–2019. - Real GDP growth: 2.2; 3.8; 4.3; 4.5; 4.7; 5.0 (2014–2019). - Effective interest rate in this scenario: 7.9; 8.8; 10.1; 10.3; 11.0; 10.9 (2014–2019). - Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Macro-Fiscal Shock, Contingent Liability Shock: each scenario lists the same baseline and shocked paths for Real GDP growth, Inflation, Primary balance, and Effective interest rate for 2014–2019 as shown in the source tables (examples include Real GDP growth under Real GDP Growth Shock: 2014: 2.2; 2015: 1.7; 2016: 2.2; 2017: 4.5; 2018: 4.7; 2019: 5.0). - Real depreciation shock example: a one-time real depreciation of 30 percent in 2013 is modeled and is shown to have a large impact on external debt dynamics. ### External debt dynamics and stress-test outcomes (Appendix V highlights) - External debt stock at end-2013/2014: $46.1 billion (16.1 percent of GDP). - Composition of external debt: - About 92 percent is medium- to long-term debt. - 99 percent is owed to official creditors, mainly by the government. - Historical increase: in 2012/13 external debt rose by about 26 percent, mainly due to financial assistance provided by Libya and Qatar. - 2013/14 support: Kuwait, Saudi Arabia, and the United Arab Emirates provided substantial financial support, mostly in the form of grants. - 2014/15 expectation: support expected mostly from the UAE in the form of loans, which will increase the external debt stock. - Medium-term projection: external debt projected to remain between 16–17½ percent of GDP over the medium term. - Stress-test specifics: - Shock levels based on 10-year historical deviations (plausible rather than extreme and permanent shocks). - Among stress tests, a large depreciation of the real exchange rate has the largest impact on external debt: a 30 percent real exchange rate depreciation in 2014 would lead to a 10 percentage point increase in the external debt-to-GDP ratio in 2019 compared to the baseline (static analysis, not reflecting trade adjustments). - A shock to the current account would raise the external debt-to-GDP ratio by 5 percentage points compared to the baseline. - An increase in external interest rates causes only a marginal deviation in the outlook. ### External debt sustainability table (selected rows and projections) - Baseline external debt (percent of GDP): 2009: 16.7; 2010: 15.4; 2011: 14.8; 2012: 13.1; 2013: 15.9; 2014: 16.1; 2015: 16.4; 2016: 17.3; 2017: 17.5; 2018: 17.3; 2019: 16.7. - Change in external debt (percent of GDP): 2014: 0.2; 2015: 0.4; 2016: 0.8; 2017: 0.2; 2018: -0.2; 2019: -0.6. - Identified external debt-creating flows (percent of GDP): 2014: -1.3; 2015: -0.1; 2016: 0.3; 2017: 0.1; 2018: -0.2; 2019: -0.9. - Current account deficit, excluding interest payments (percent of GDP): 2014: 1.1; 2015: 3.7; 2016: 4.7; 2017: 4.7; 2018: 4.7; 2019: 4.6. - Exports (percent of GDP): 2014: 15.2; 2015: 13.2; 2016: 12.0; 2017: 12.3; 2018: 12.5; 2019: 12.7. - Imports (percent of GDP): 2014: 24.1; 2015: 21.6; 2016: 20.5; 2017: 20.2; 2018: 19.9; 2019: 19.8. - Net non-debt creating capital inflows (negative, percent of GDP): 2014: -1.8; 2015: -3.0; 2016: -3.4; 2017: -3.5; 2018: -3.7; 2019: -4.3. - Automatic debt dynamics contribution (percent of GDP): 2014: -0.6; 2015: -0.9; 2016: -1.0; 2017: -1.1; 2018: -1.2; 2019: -1.3. - External debt-to-exports ratio (in percent): 2014: 105.8; 2015: 124.6; 2016: 143.8; 2017: 142.4; 2018: 138.6; 2019: 131.4. - Gross external financing need (in billions of US dollars): 2014: 11.6; 2015: 22.6; 2016: 24.6; 2017: 25.7; 2018: 24.7; 2019: 25.7. - Gross external financing need (in percent of GDP): 2014: 4.2; (additional year-by-year percent of GDP values are shown in the table). ### Analytical implications emphasized in the source - Growth and real interest rate developments are the main vulnerabilities for public debt dynamics; downside growth surprises or increases in domestic real rates materially worsen debt trajectories. - Short debt maturities amplify fiscal sensitivity to interest-rate shocks through higher near-term interest expenditures. - External-debt stress tests identify real exchange rate depreciation and current account shocks as the most consequential for external debt ratios. *Source: IMF staff.* ### Appendix VI. External Sector Assessment ### Appendix VI. External Sector Assessment ### Overview - Staff analysis: direction of exchange rate policy is extremely important for the sustainability of Egypt’s external sector. - Serious risks: combination of inflation above that of trading partners with limited movement of the nominal exchange rate during the projection period. - Policy direction favored: macroeconomic and structural reforms to restore investor confidence and boost competitiveness, coupled with the introduction of greater exchange rate flexibility, would improve sustainability and reduce risks. - Assessment: The exchange rate appears overvalued based on the standard IMF methodologies. - Short-term support: The current account has recently been supported by temporary GCC financing. - External environment: Global trade shares have declined and capital flows are low and volatile, although there are initial signs that investor confidence is coming back. - Structural indicators: Qualitative indicators point to structural weaknesses. - Reserves: The reserve level is below standard levels of adequacy based on the Fund’s reserve adequacy metric. ### Exchange rate assessment - Real effective exchange rate (REER) dynamics: - As of October 2014, REER has appreciated by 11 percent since end-2010 due to persistent inflation differentials with trading partners and limited exchange rate flexibility despite several nominal adjustments totaling 19 percent. - Over a longer time horizon, REER appreciated considerably, mainly due to the episode of high inflation starting in 2008 that reversed competitiveness gains from early 2000s nominal depreciation. - Current REER level is about 28 percent above its average of the past 15 years and 29 percent above its average of the past 10 years. - Overvaluation estimates: - IMF’s REER assessment methods yield an estimated overvaluation ranging from 3–28 percent. - These estimates are subject to uncertainty, including due to structural changes in the economy. - Implications: - Limited price competitiveness consistent with persistently high non-energy trade deficit. - Trade deficit in recent years largely financed by official transfers. - Decline in Egypt’s share of world non-oil exports consistent with the REER findings. ### Competitiveness and trade - Global trade share: - Share of non-oil exports fell by more than 40 percent between 2008/09 and 2013/14 to 0.09 percent of global non-oil exports. - Export composition: - Egypt has diversified over the last 20 years and is relatively more diversified compared to other countries in the region and to emerging and developing economies as a group. - Oil and gas exports still represent close to 50 percent of total exports in 2013/14. - Oil trade balance is about -0.6 percent of GDP. - Structural and qualitative indicators: - World Bank 2014 Doing Business rank: 112 out of 189. - World Economic Forum 2014–15 Global Competitiveness Index rank: 119 out of 144. - Weaknesses highlighted: labor and goods market efficiency, financial market development, education. - Infrastructure deficits: poor transportation infrastructure, traffic congestion, distribution bottlenecks, and electricity, fuel, and water shortages. ### Current account and financing - Current account trends: - Current account deficit has declined in recent years, largely due to GCC financing. - Nature of GCC financing: - Mostly official transfers, government deposits, and in-kind oil grants. - Some GCC countries pledged substantial financing in 2014/15; early indications suggest this will take the form of loans rather than grants. - Future financing prospects from the GCC beyond 2014/15 are less certain. - Continued decline in oil prices may weigh on the downside and potentially discourage FDI that could unlock higher future production and oil exports. - GCC assistance FY13/14 (US$ Billion) — components and totals as presented: - Saudi Arabia: Donor Deposit at the CBE* 2.0; Grant** 2.0; Energy products** 3.8; Total 7.8 - UAE: Donor Deposit at the CBE* 2.0; Grant** 2.7; Energy products** 3.2; Total 7.9 - Kuwait: Donor Deposit at the CBE* 2.0; Grant** --; Energy products** 0.7; Total 2.7 - Qatar: Donor Deposit at the CBE* --; Grant** --; Energy products** 0.2; Total 0.2 - Total: Donor Deposit at the CBE* 64.7; Grant** 7.9; Energy products** 18.6 ### Capital flows and reserves - FDI and portfolio flows: - FDI has been on a declining trend since 2009 but appears to be picking up. - Political instability, deterioration of macroeconomic fundamentals, and poor business environment depressed investment. - FDI in the past three years has been less than 1.5 percent of GDP. - Portfolio investment has been historically low and highly volatile, with massive outflows during periods of global financial stress and domestic political instability. - Signs of improvement: return of political stability and measures to address subsidy and energy issues improved investor confidence; FDI registered strong growth in Q1 2014/15, with investor interest particularly in the oil sector. - Reserves adequacy: - As of end-December 2014, reserves stood at 2½ months of imports or 40 percent of the standard reserve adequacy metric for fixed exchange rate regimes. - This represents a large drop from the average coverage of 117 percent of the reserve adequacy metric for the past 10 years. ### Policy implications and recommendations - Key policy priorities identified in the text: - Introduce greater exchange rate flexibility to reduce sustainability risks associated with high inflation differentials and limited nominal exchange rate movement. - Implement macroeconomic and structural reforms to restore investor confidence and boost competitiveness. - Address long-standing subsidy and energy-related issues to improve investor confidence and attract FDI, notably in the oil sector. - Recognize uncertainty in GCC financing beyond 2014/15 and plan for risks to external financing, especially if oil prices decline. - Structural reform focus areas implied by qualitative indicators: - Improve the business environment to reduce red tape and cumbersome regulations. - Enhance labor and goods market efficiency, financial market development, and education. - Address infrastructure deficits: transportation, distribution, electricity, fuel, and water. *Source: Appendix VI. External Sector Assessment, IMF staff report (November 2014/January 13, 2015 excerpts).* ### 3. Effective December 30, 2012, the CBE introduced a multiple price auction mechanism to buy ### _cr1533 - 3. Effective December 30, 2012, the CBE introduced a multiple price auction mechanism to buy ### Foreign exchange policy and market developments - Effective December 30, 2012, the CBE introduced a multiple price auction mechanism to buy and sell foreign exchange. - In addition to regular weekly auctions, the CBE held occasional exceptional auctions to cover outstanding import needs for priority imports. - Restrictions imposed by the CBE on the auctions and on the interbank market led to an insufficient supply of foreign exchange at the daily exchange rate determined by the central bank and contributed to the development of a parallel foreign exchange market. ### Technical assistance (selected 2011–2014 activities) - FAD and METAC missions: November 2011; January and June 2013; August–September 2014; November 2014 — public financial management. - FAD missions: July 2011; April–May 2014; June 2014; August–September 2014 — revenue administration. - FAD missions: October and December 2013; February, April, June, and September 2014 — tax policy. - FAD mission: May 2011 — expenditure and tax policy. - METAC missions: March 2012; March 2013; September 2014 — prices and external sector statistics. - METAC missions: September and December 2014 — bank supervision. - MCM mission: February 2012 — monetary policy. - LEG missions: December 2013; January 2014; August–September 2014 — tax legislation. - Egypt participated in the FSAP in 2002; updated in 2007. - Resident Representative/Advisor: None. ### Relations with the World Bank Group (JMAP Implementation, FY14 — as of December 23, 2014) - Bank work program (next 12 months) — selected items and timing: - Support preparation of the Economic Development Conference (March 13–15, 2015) — Ongoing support Dec 2014–March 2015. - Draft a white Paper for Government of Egypt on the energy sector for the Economic Summit of March 2015 — January 2015. - Provide hands-on support to the Debt Management Unit of the Ministry of Finance — December 2014. - Programmatic TA to improve targeting mechanisms and efficiency of social sectors; capacity building; produce a new poverty assessment — 18-months program. - Help Ministry of Planning establish a macro policy unit and enhance macroeconomic and poverty forecasting capacity — January 2015 (concept note). - Strategic and operational advice to the Macro Fiscal Policy Unit on forecasting tools and quarterly macoeconomic risk assessment report — January 2015 (concept note). - IMF work program in next 12 months — selected items and timing: - 2014 Article IV Consultation — Nov 11–25, 2014. - Staff Visit — May 2015. - 2015 Article IV Consultation — November 2015. - Technical assistance missions on public financial management, revenue administration, bank supervision (METAC), external sector statistics (METAC) — November 2014; September 2014; September 2014; September 2014 respectively. - Additional TA missions planned on tax policy, revenue administration, public financial management, and banking supervision for remainder of FY15 — January 2015; May 2015; January 2016 noted in schedule. ### Statistical issues (as of end-December 2014) - General assessment: - Data provision broadly adequate for surveillance; quality, timeliness, and transparency could be improved. - Government finance, monetary, and external sector statistics are adequate and recent efforts have improved transparency and dissemination. - Only aggregate banking data available; quarterly data on general government available only with a lag. - Finances of state-owned enterprises and their relations to the budget, particularly in the energy sector, remain non-transparent. - National accounts: - Compiled by National Accounts Department (Ministry of Economic Development) based on SNA 1993. - Shortcomings: inconsistency over time (base year changes without overlap), inconsistency with balance of payments, weakness in inventory data, lack of export and import price deflators. - Price statistics: - CAPMAS disseminates monthly producer price index and monthly CPI data for Upper, Lower and all Egypt. - CPI uses expenditure weights from the 2008‒09 household expenditure survey. - In October 2009, the CBE began releasing a measure of core inflation (excludes most volatile food items and regulated prices) and issuing a monthly Inflation Note. - Government finance statistics: - Authorities have largely adopted GFSM 2001 classification for revenue and expense transactions. - Data for general government operations under GFSM 2001 are incomplete. - Lack of GFSM 2001 compliant presentation of transactions in assets and liabilities, other economic flows, and stock positions limits fiscal analysis. - External and domestic public debt compiled and disseminated separately by CBE and Ministry of Finance; more comprehensive single database recommended. - Monetary and financial statistics: - Monthly monetary and financial statistics are comprehensive and generally reported within two months, but coverage should be expanded to include other financial corporations. - Financial sector surveillance: - CBE regularly publishes financial soundness indicators; only aggregate banking sector data publicly available. - Banks’ exposure to large State-owned enterprises remains non-transparent. - External sector statistics: - CBE compiles balance of payments based on BPM5; publishes Egypt’s Reserve Template on the IMF’s website since 2009. - Remaining shortcomings: (i) source data not approximating an accrual basis; (ii) unreliable merchandise trade statistics from customs declarations, compilers estimate using banks’ foreign exchange records; (iii) limited coverage and classification of foreign exchange transactions. - METAC provided advice on measurement of FDI and development of an FDI survey and business register. - CBE publishes international investment position; shortcomings remain to connect stocks with flows, improve reporting on nonguaranteed debt, and address residency criteria. - Data Standards and Quality: - Egypt began participation in the Special Data Dissemination Standard in 2005. - The data ROSC was published on July 2005. ### Article IV Consultation — Press Release highlights (February 11, 2015; Board concluded Jan 28, 2015) - Context and recent history: - Following four years of political uncertainty and economic slowdown, authorities have started implementing policies to raise growth, create jobs, and restore macroeconomic stability. - For the last four years, growth has been only 2 percent on average; unemployment rose to over 13 percent; poverty increased to 26.3 percent in 2012/13. - Fiscal deficits have been above 10 percent of GDP since 2011; general government debt reached 90.5 percent of GDP in mid-2014. - Reserves declined from 6.8 months of imports in mid-2010 to 2½ months of imports in December 2014. - Banking system remained resilient with maintained profitability, low non-performing loans, and high liquidity. - Outlook and projections: - Measures implemented and recovery in confidence are starting to produce a turnaround. - Growth is projected to reach 3.8 percent in 2014/15 and to rise steadily to 5 percent over the medium term. - Fiscal consolidation will bring the budget deficit below 8 percent of GDP by 2018/19 and set government debt on a downward path. - Adjustment preserves growth and inclusiveness: increase in spending on health, education, and scientific research mandated by the constitution; reform subsidies; raise taxes on high earners; strengthen social safety nets via cash transfer systems. - Targeted reduction in inflation to 7 percent over the medium term. - Authorities aim to increase reserves to the equivalent of 3 months of imports by end-2014/15 and 3½ months of imports over the medium term; continued external financing will be needed. - Risks: - Vulnerable to adverse global economic developments, regional security risks, domestic shocks, and possible policy slippages. - Upside risks if authorities’ policies and reforms are successfully implemented. ### Executive Board Assessment — key messages - Directors welcomed improved economic outlook and authorities’ plans to restore macroeconomic stability and spur inclusive growth and employment. - Emphasized importance of policies to restore growth, create jobs, and protect the poor; regulatory reform, investment climate, and financial sector development critical to unlock private-sector-led growth. - Welcomed focus on improving infrastructure and reforming the energy sector; stressed careful design and monitoring of projects given limited public resources and high public debt to avoid actual or contingent liabilities. - Supported policies to protect the poor: launch of new cash transfer scheme; reform of food ration cards; increase in public spending on education, health, and research if managed wisely. - Fiscal consolidation essential for macroeconomic stability and medium-term sustainability; commended measures to increase revenues and contain spending, especially the fuel subsidy reform begun in 2014. - Agreed on need to broaden tax revenues and control current spending, including: enact a modern VAT swiftly; continue reforms of subsidies and public sector wage-setting and hiring. - Noted opportunity from decline in oil prices to accelerate energy subsidy reforms. - Fiscal consolidation would support CBE objective of bringing inflation down to single digits. - Directors saw a more flexible exchange rate, reflecting supply and demand and consistent with adequate reserves, as a way to improve availability of foreign exchange, strengthen competitiveness, support the current account, and attract FDI; welcomed recent exchange rate movements. - Stressed importance of building confidence and creating adequate buffers by implementing reform agenda, strengthening international reserves, and preparing budget contingency plans. ### Selected macroeconomic indicators and projections (2009/10–2015/16) - Output and prices (annual percentage change): - Real GDP (market prices): 1.8; 2.2; 2.1; 2.2; 3.8; 4.3 - Consumer prices (end-of-period): 11.8; 7.3; 9.8; 8.2; 11.0; 10.5 - Consumer prices (period average): 11.1; 8.6; 6.9; 10.1; 10.4; 10.1 - Public finances (percent of GDP at market prices) — General government: - Revenue and grants: 22.0; 22.1; 23.0; 25.0; 24.3; 23.7 - Expenditure (incl. net acquisition of financial assets): 31.8; 32.7; 37.1; 38.6; 35.2; 32.2 - Of which : Interest: 5.6; 5.9; 7.7; 8.0; 7.9; 7.5 - Overall balance: -9.8; -10.5; -14.1; -13.6; -11.0; -8.5 - Overall balance, excl. grants: -10.0; -11.2; -14.4; -17.4; -12.0; -8.6 - Primary balance: -4.7; -5.1; -6.6; -6.1; -3.6; -1.4 - Gross Debt: 76.6; 78.9; 89.0; 90.5; 89.8; 87.1 - External: 11.8; 9.8; 11.4; 10.4; 11.0; 12.2 - Domestic: 64.8; 69.1; 77.6; 80.1; 78.8; 74.9 - Budget sector (percent of GDP): - Revenue and grants: 19.3; 19.3; 20.0; 21.8; 21.3; 20.9 - Expenditure (incl. net acquisition of financial assets): 29.2; 29.9; 33.7; 35.7; 32.2; 29.4 - Of which: Fuel subsidies: 4.9; 6.1; 6.8; 6.3; 3.1; 1.2 - Of which: Food subsidies: 2.4; 1.9; 1.9; 1.8; 1.4; 1.3 - Overall balance: -9.8; -10.6; -13.7; -13.8; -11.0; -8.5 - Overall balance, excl. grants: -10.0; -11.2; -14.0; -17.6; -12.0; -8.6 - Primary balance: -3.7; -4.0; -5.3; -5.2; -2.5; -0.4 - Monetary sector (annual percentage change): - Credit to the private sector: 1.0; 7.1; 9.8; 7.4; 11.7; 14.9 - Reserve money: 23.6; 5.1; 20.4; 14.8; 16.2; 11.2 - Broad money (M2): 10.1; 8.3; 18.4; 17.1; 15.2; 11.8 - Treasury bill rate, 3 month (average, in percent): 10.2; 13.4; 13.4; 11.3; 9.5; 11.2 - External sector (in percent or levels as shown): - Exports of goods (in US$, percentage change): 13.1; -7.1; 7.6; -3.2; -14.0; -5.9 - Imports of goods (in US$, percentage change): 10.4; 9.5; -2.6; 3.7; -1.4; 4.7 - Merchandise trade balance: -11.5; -13.0; -11.3; -11.8; -11.4; -11.5 - Current account: -2.6; -3.9; -2.4; -0.8; -3.4; -4.3 - Capital and financial account (incl. errors and omissions): -1.1; -2.8; 2.1; 1.6; 3.1; 3.2 - Foreign direct investment (net, in billions of US$): 1.2; 3.7; 3.6; 3.8; 6.9; 7.6 - External debt: 14.8; 13.1; 15.9; 16.1; 16.4; 17.3 - Gross international reserves (in billions of US$): 26.4; 15.2; 14.5; 16.3; 18.7; 21.2 - In months of next year's imports of goods and services: 4.7; 2.7; 2.5; 2.8; 3.1; 3.2 - In percent of short-term external debt: 542.4; 308.8; 138.1; 191.9; 116.9; 115.2 - Memorandum items: - Nominal GDP (in billions of Egyptian pounds): 1,371.1; 1,575.5; 1,753.3; 1,997.6; 2,295.4; 2,631.3 - Nominal GDP (in billions of US$): 235.6; 262.3; 271.4; 286.4; ...; ... - GDP per capita (in US$): 2,930; 3,183; 3,205; 3,304; ...; ... - Unemployment rate (period average, percent): 10.4; 12.4; 13.0; 13.4; 13.2; 12.7 - Poverty rate (percent): 25.2; n.a.; 26.3; ...; ...; ... - Population (in millions): 80.4; 82.4; 84.7; 86.7; 88.4; 90.2 - Notes: - Fiscal year ends June 30. - General government includes budget sector, National Investment Bank (NIB), and social insurance funds. - Budget sector comprises central government, local governments, and some public corporations. - External debt includes multilateral and bilateral public sector borrowing, private borrowing and prospective financing (in 2011/12). *IMF staff report and related materials as presented in the provided content unit.* ### 1. This is a moment of opportunity for Egypt. With relative political stability restored ### 1. This is a moment of opportunity for Egypt. With relative political stability restored ### Authorities' assessment and priorities - Authorities are moving to invigorate the economy, strengthen economic prospects, and improve the well being of all Egyptians through structural reforms and investment promotion. - Immediate steps: 2014/15 budget to adjust spending allocations, contain the fiscal deficit, and bring down public debt; monetary policies to contain inflation. - Investment promotion and job creation are key priorities anchored in fundamental economic reforms and a predictable and competitive investment environment. - The March Conference in Sharm El Sheikh is intended to bring together investors to participate in projects to reinvigorate the economy. - Authorities broadly share staff’s assessment of long-standing challenges but expect a stronger turnaround in business confidence and larger investment flows. ### Outlook - Recent trajectory: - Four years of growth averaging 2 percent. - Pace of economic activity expected to double in 2014/15 and to further increase thereafter. - Growth rebounded to 6.8 percent y-o-y in Q3 of 2014 with strong pickup in manufacturing and tourism. - Authorities see scope for stronger growth from: - energy sector, new project investments, tourism, communications, and construction. - more positive spillover from lower oil prices on Egypt’s trading partners. - Authorities anticipate medium-term growth boost from investment in: - industrial projects, energy generation, superhighways, social sectors, regulatory reforms for startups, and support to small and medium enterprises. - Flagship project: Suez Canal Regional Development project with plans including four new seaports in the three provinces surrounding the canal, a new airport, a new industrial zone west of the Gulf of Suez and a “technology valley” in Ismailia. ### Fiscal Policy - Commitment: restore fiscal sustainability via planned large fiscal consolidation. - Recent deterioration: - Debt has increased by one third. - Budget sector’s gross financing needs nearly tripled. - 2013/14 budget deficit peaked due to petroleum sector revenue shortfalls and two stimulus packages. - Social spending mandates: floor on public spending on health and education in new constitution requires additional fiscal savings elsewhere. - Current budget and fiscal targets: - This year’s budget targets a deficit of 10 percent of GDP. - Revenue and expenditure measures introduced that yield 2½ percent of GDP. - Planned additional measures aim to reduce the deficit to 8 percent of GDP and bring government debt to a declining path, reaching 80-85 percent of GDP within five years. - Specific fiscal measures enacted or under consideration: - Subsidy cuts via fuel price increases of 40-80 percent implemented last July. - Gas price increases to households by over 200 percent. - Tax measures on dividends and capital gains, implementation of a new property tax, income taxes at the higher income brackets, and excises on tobacco and alcohol. - Measures to contain the public wage bill and an overhaul of the public pay system under consideration. - Subsidy reform elements: - New food ration cards yielding substantial savings due to lower wheat consumption and better targeting. - Smart cards for subsidized fuel distributed and used in five governorates and being extended. - Recent oil price decline substantially reduced budgetary cost of fuel subsidies for this fiscal year, but authorities recognize the possibility of a faster rebound in oil prices than futures imply. - Authorities paid $3.5 billion in amounts due to foreign oil companies since July, leading to new investments. - Power shortages to be addressed by new power projects and private sector participation in renewable energy based on a newly established feed-in tariff, which was three times over-subscribed. ### Monetary, Exchange Rate, and Financial Sector Policies - CBE monetary policy objectives: - Gradually reduce inflation to maintain real incomes and enhance external competitiveness. - Anchor low and stable inflation expectations while supporting growth and employment. - Recent policy actions: - Monetary Policy Committee raised interest rates by 100 basis points in July 2014 to contain second-round effects of fuel price increases. - On January 15, 2015 the Committee cut the benchmark interest rate 50 basis points reflecting an improved inflation outlook after a drop in international oil prices and revised food price forecasts. - Exchange rate policy: - Aim for a flexible exchange rate reflecting supply and demand and consistent with adequate reserves while avoiding excess volatility. - CBE conducted foreign exchange auctions to maintain an orderly market. - Exchange rate depreciated in the central bank auctions by 3½ percent in the week of January 18, 2015. - Authorities expect to benefit from returning capital inflows, particularly FDI, given renewed confidence; they expect a more positive impact on the balance of payments than staff projections. - Authorities consider imports and exports relatively inelastic to the exchange rate due to non-price constraints; note that large REER depreciations in 2003 were not followed by a strong net exports response. - Authorities are concerned that the exchange rate assessment in the staff appraisal could lead to undue pressures on the currency given methodological problems. - Banking sector resilience: - Banking system resilience remains intact despite slowdown during political transition. - Profitability improving and nonperforming loans declining. - Provisioning coverage has reached 98 percent. - CBE stress tests indicate plausible losses could be absorbed by banks’ profits and capital buffers. ### Structural Reforms for Sustainable Growth - Objective: raise growth potential and medium-term growth rates to meaningfully lower unemployment and raise living standards. - Priority areas: - Enhance financial inclusion and improve business climate. - New microfinance law and plans to develop mobile banking to enhance access to financial services. - Tackle regulatory and bureaucratic obstacles for domestic and foreign investors; ensure transparency and rule of law. - Amendments introduced to competition and anti-monopoly laws. - Steps taken to remove legal hurdles facing private contracts with the government and planned amendments to the investment law to streamline foreign investment processes. - Authorities view the March conference as a landmark event to jumpstart investment flows. ### Selected Issues Paper and diagnostics - Authorities welcome identification of binding constraints to growth and prioritized structural reform recommendations using the “Growth Diagnostics” approach. - They do not disagree with most views in the Selected Issues Paper but sought: - more empirical evidence on some views, - further prioritization of reforms, - clearer connection with paragraph 42 of the staff appraisal. - Note on business climate indicators: table based on World Economic Forum perceptions survey data shows wide year-to-year fluctuation for most rankings except political stability and access to finance, complicating conclusions. *Source: Authorities’ views and policy statements as presented in the document.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1533.pdf_