Transcript of Press Briefing on Egypt’s Economic Reform Program Review with Subir Lall IMF Mission Chief for Egypt, Middle East, Central Asia

September 27, 2017

MODERATOR: Good morning, everyone. Welcome to our online viewers. My name is Randa Elnagar. I'm a Press Officer with the IMF, and I have with me here, Subir Lall, the Mission Chief for Egypt.

We are going to have a Press Conference on the release of Egypt's documents for the first review. Subir is going to give us some opening remarks, and then he's going to take your questions. Subir.

MR. LALL: Thank you, Randa; and good morning from Washington. Before I take your questions let me provide some very brief introductory remarks as we release the report for the first review of the Fund- supported program. The Egyptian authorities have embarked on ambitious reform program and have taken decisive measures aimed at restoring macroeconomic stability and sustainable public finances; while at the same time strengthening social protection to shield the most vulnerable.

Just to remind ourselves about the objectives of the Authorities' Reform Program. The program was initiated to address long-standing challenges in the Egyptian economy. These included a balance of payments problem, manifested in an over-valued exchange rate and foreign exchange shortages, large budget deficits that led to rising public debt, and low growth and high unemployment.

Resolute implementation of the policy package under the program was seen as essential to restore investor confidence, reduce inflation to single digits by the end of the program, rebuild international reserves, strengthen public finances and encourage private-sector-led growth.

In terms of the key components of the program, liberalization of the foreign exchange rate and floatation of the currency was seen as necessary to alleviate chronic foreign exchange shortages and restore competitiveness.

The policy package also included reducing fiscal deficits to put public debt on a firmly downward path. To mitigate the impact of this reform on the poor, the authorities aim to use part of the fiscal savings to strengthen social safety nets. It also included structural reforms to address deep-seated impediments to growth and job creation, and to create an enabling environment for private sector development.

In line with these objectives the measures that have been taken by the authorities were bold, and we agree they were necessary to reverse the buildup of imbalances that were hindering higher growth and job creation.

Although it is still early days, the first review provides us an important opportunity to take stock of where we are and how the economy is evolving and how this will help us to get a clearer picture of what the outlook is.

The program is off to a strong start and its beneficial effects should become increasingly evident in the period ahead. First on growth, while it is still at an early stage, we have seen gathering strength in economic activity. If we look at the last fiscal year, for which we now have full-year data, we have seen a clear pick-up in the economic activity.

While we expected GDP growth of about 3.5 percent during fiscal year 2016/17, it came in at 4.2 percent. Looking a bit deeper at the quarterly growth profile, it was 3.5 percent in the first quarter of the fiscal year and ended the fiscal year at 5 percent. This seems clear evidence that activity has strengthened over the past year, and the drivers of this growth were manufacturing, construction, retail trade, transport and communication. So that suggests that broad-based growth is taking hold.

Regarding foreign exchange markets and its liberalization, with the liberalization of this market the parallel market for foreign exchange has been eliminated and the foreign exchange shortages have disappeared. Foreign exchange can be acquired freely in the market at the market rate. The exchange rate depreciated after the floatation and has now stabilized.

At the same time we have seen a sharp increase in foreign exchange reserves, reflecting the inflows of capital as confidence was restored, as well as the increase in exports and the decline in imports which were a direct consequence of a more competitive exchange rate.

We are now in a new monetary policy framework where exchange rates act as shock absorbers. While it is important to maintain adequate reserve buffers, as the system and the foreign exchange market matures, movements in foreign exchange reserves and in the exchange rate should be seen as the mechanism through which changes in the external environment are absorbed without being transmitted into the domestic economy.

This is completely normal and expected in any framework with flexible exchange rates, and I'm hopeful this will be internalized by all market participants over time as they get used to the new framework. In fact, it is a sign that reserves and exchange rates are playing their role in shielding the economy from changes in the external environment, and thereby helping stabilize GDP growth, and inflation, and employment.

On the fiscal sector, this has been an area where great strides have been made, both on the revenue and expenditure side. The introduction of the value-added tax, the VAT, is a major tax reform for any country to undertake. It significantly improves the prospects for revenue collection. At same time, on the expenditure side, wage restraint and reforms of energy subsidies have helped alter the path of budget expenditures and that contributes importantly to arresting the rise in public debt.

Some of the fiscal savings from these two measures have been utilized by the authorities to expand social spending to support the less well-off. Energy subsidies tend to highly regressive, benefitting most those who are already wealthy. Expanded cash transfers including through the Takaful and Karama programs and the expansion to more households will ensure that the funds are reaching those who need it the most.

Finally, what about inflation? Inflation pressures rose for a number of reasons, including the depreciation of the exchange rate, the introduction of the VAT, and reforms of energy subsidies. In response to inflation, the Central Bank of Egypt appropriately tightened monetary policy to prevent second-round effects. Recent evidence suggests these one-off factors have been digested, and the most recent monthly data indicate a deceleration in both core and headline inflation.

In August, headline inflation rose 1.1 percent month-on-month, after 3.2 percent in the previous month. Core inflation rose 0.3 percent that month. This is the first time that core monthly inflation has fallen below 0.5 percent since July 2016.

Now, one month does not indicate a trend, so these are preliminary signs and we need to continue following them closely. However, we expect inflation to continue on a disinflationary path given the appropriately strong and credible policy stance of the Central Bank of Egypt. This would lead inflation to decline to slightly above 10 percent by the end of the current fiscal year, so by June 2018, and then to single digits by 2019.

With these remarks, I will be happy to take your questions now.

MODERATOR: Okay, we have a lot of questions, for that I'm going to lump them up together, we have similar questions from many news agencies.

I'm going to start with this question: "When is the third disbursement expected and how much will it be? What conditions does Egypt still have to meet? What is your assessment of Egypt missing its June targets? What are your forecasts on inflation through this fiscal year, and when do you advise cutting interest rates?" It's quite long and is like five questions in one, but it answers a lot of questions that we received online.

MR. LALL: Yes. Thank you, Randa, and thank you for the question. And it's a very broad set of questions so let me try to provide a comprehensive answer. In terms of the third disbursement, that would follow after the second review of the program, which is expected to be completed by the IMF Executive Board by the end of December, so before the new year. And with that would be a disbursement of an additional amount equivalent to USD2 billion.

Now with regard to the performance so far; as I mentioned in my opening remarks we are off to a very strong start. While it is true that one of the criteria for June was not met, but that was due to factors outside the control of policymakers, and that had to do with the exchange rate depreciation being more than what was expected, and so as a result of that on the fuel prices, and on the fiscal consolidation, the targets were not fully met.

But since the policy actions taken were appropriate, and this was due to exogenous factors, that was not a major issue. Now looking forward the authority's reform programs have been outline in great detail in their memorandum of economic and financial policies where are contained in the package that you will receive today. And so those outline what the priorities for near term are, and of course the overall objectives of the program have not changed.

Finally, with regard to interest rates and monetary policy, as I mentioned in my opening remarks, the monetary policy stance has been appropriate and it was necessary to reduce the scope for second-round effects because of the one-off factors of the exchange rate depreciation, the increase in the VAT rate, and the increase in fuel prices.

So, the monetary stance has helped, and I cited the numbers before, and we've seen very preliminary signs that inflation may be easing. Although again, I will caution, it's still very early days yet. Thank you.

MODERATOR: Another question "Does Egypt need to need to maintain high interest rate environment and weak pound to keep inflows into T-bills coming in?"

MR. LALL: Thank you for that question. And now, again, as regards the exchange rate, with the move to the float, the exchange rate is not a policy target, and the exchange rate will move depending on various factors including of course the overall monetary policy stance as well as capital inflows and developments in the current account.

Now, so coming to interest rates, as I mentioned, the monetary stance has been appropriate so far, and then we will continue to observe data, and will have discussions with the authorities for the next review, and will get their take on how appropriate the monetary policy stance is, and whether their path of inflation or the path of disinflation is coinciding with our own.

MODERATOR: Questioner asks "The Egyptian Stock Exchange rate is pushing to amend the stamp tax on transactions which was implemented last May. If this happens would it be against the terms of the agreement with the government?"

MR. LALL: Thank you. The stamp tax was definitely a part of the authorities' economic program when it was implemented earlier this year. Now, I'm not going to comment on a hypothetical scenario about changes in the stamp tax, and what may or may not happen if certain changes are not made.

MODERATOR: What is the IMF's comment on exchange rate stability and how does it see it valued now?

MR. LALL: Thank you. Now, as I mentioned, and I guess it bears repeating, that the exchange rate is determined by market forces, so if the exchange rate is stable, it reflects the stability of inflows and outflows. I'm sorry, what was the second part of the question?

MODERATOR: How do we value the exchange rate now?

MR. LALL: So, the exchange rate depreciation that happened in the initial part, and you see this in the report led to a real effective exchange rate depreciation of about 27 percent, 26.8 percent, and that was needed to restore competitiveness, and that was what we are seeing now because it has been fairly stable for the last six months or so.

Going forward, though competitiveness will not, in the new framework, and cannot, rely on the exchange rate, or the nominal exchange rate, and it has to do with disinflation and the path of inflation going forward over the next couple of years, as well as other reforms that are important for competitiveness. Exchange rate competitiveness is only one angle, and in the new policy framework since they are market determined, we need to focus more on broader measures of competitiveness.

MODERATOR: Here is another question "Is the IMF Mission coming to Egypt soon? What will be the recommendations and observations?"

MR. LALL: Well, yes. Thank you. Because the disbursements, the expected next tranche of the Fund-supported program of the authorities was expected to take place by the end of the year, we hope to visit Cairo in the last quarter of this year, and then we'll have discussions, we'll review developments since the last mission, and then on the basis of that we will discuss with authorities the specific policies and the overall policy mix.

MODERATOR: Another online question "Will Egypt need to further energy subsidy reform to improve the budget deficit?"

MR. LALL: The authorities have already indicated that by the end of the program full cost recovery is planned for the various elements of energy, except LNG, cooking gas. And so we expect that to happen over the course of, and as mentioned, the end of the program, because we have not reached cost recovery yet, it is in the mid-50s at the moment. But keep in mind that this reflects a number of factors including the movements in the exchange rate and

international fuel prices and how much is imported. And so, we will have to look at developments in these different elements over the coming period and then form a view on what might be needed and when that would be appropriate.

MODERATOR: I have a lot of questions from different agencies most of them again on inflation.

When do we expect it to decline and what are the requirements for the third tranche to be disbursed?

MR. LALL: Thank you Randa. I think did answer these questions already --

MODERATOR: Yes, but on inflation we might need to repeat the message.

MR. LALL: Well, I mean yes. It is our expectation that -- I will repeat the answer --

MR. LALL: As I said that inflation is expected to come down over the coming months, and we expect it to fall to slightly over 10 percent by the end of the fiscal year, so in June, 2018, and then definitely reach single digits by the following year.

And, so that's our outlook -- and as I mentioned, I gave some very preliminary data, but again emphasizing caution, because this data tends to be volatile, there are seasonality factors, and one month certainly does not make a trend. But, we are optimistic that inflation is on a downward path given the appropriate and very credible policy stance of the Central Bank of Egypt.

Now as regards requirement of the program, let me restate the objectives of the authorities’ program have not changed.

And in terms of the measures that authorities have committed to doing under this program, they are spelled out in the report, and I would strongly encourage you to go through them again and that will answer your question in more detail, than is possible at this moment.

MODERATOR: One question from again on how do you evaluate the investment environment in Egypt?

MR. LALL: Now, let me answer this question in a broader context. Why is the investment environment important? If you look forward to where we would like to be, where Egyptian economy would like to be, and what we think is possible.

It is possible to raise growth to a higher level, potential growth, underlying growth if you like, and that would be also needed to supply the kinds of jobs and the high paying jobs that will meet the additions to the labor force that will take place in the coming years and the coming decades.

And so, an important component of that will have to be private investment, because it is private investment and job creation that can meet the demand for jobs that will be expected to arise due to demographic trends and also as more women get incorporated into the labor force, given that labor force participation of women is relatively low in Egypt at the moment, and it points to a great under-utilized potential for growth going forward.

With that in mind, the investment environment is of course important to encourage private investment, and there are several measures that have been taken, and the authorities have recently, that should go a long way towards improving the environment compared to the past.

There have been provisions made to encourage lending to small and medium enterprises where a lot of job creation takes place particularly.

But in addition, the investment law that was passed recently, the bankruptcy law which modernizes the framework along the lines of international practice, these are all measures that can help improve the investment climate, as well as the licensing law, which makes it much easier to set-up new businesses; and the time taken to set-up new businesses is aimed to, and is expected to shrink dramatically from what it used to be, over 600 days to acquire license to around 30 days, which would be in line with best practices.

So, all these are very important and very decisive measures that have been taken and go all in the same direction, of improving the investment environment for Egypt and going forward.

Finally, a very important pre-condition for a strong investment and sustained investment, is a stable macro-economic environment, and all the measures that have been taken on the fiscal policy side and the monetary policy side, go towards that essential pre-condition, which is low inflation and sustainable public finances, and at the same time, supporting the reorienting some of the spending to those who were at the lower end of the income spectrum. Thank you.

MODERATOR: I have a lot of repeated questions, but I know that there is one, that is being asked by everyone. When will the Egyptian people feel an improvement in their economic situation, and reap the fruits of the government foreign program?

This is something that everyone is asking about, everyone has done the work, what's next? When do we see the results?

MR. LALL: Yes, and that's a very valid question because the Egyptian people have obviously seen big changes in economic policy in the last year and many important changes. The change in the tax regime, the change in how the social protection system is working, and changes on energy subsidies on the exchange rate as I mentioned.

So, the question is how does this translate into the benefits for the lay person; and as I said we are optimistic that the policies went all in the right direction, but also that they were necessary, given the build-up of imbalances and the policy mix in place for a number of years before, was not sustainable.

But now, we are seeing with the strong consolidation efforts for example, arresting the increase in public debt. We expect that to decline. Now why does it matter? Because when public debt declines, interest payments decline. When interest payments decline, it opens up more space to spend on social programs and also to spend on increasing human capital in the labor force, and increasing required investment in infrastructure which will ultimately lead to more jobs and more growth and more incomes.

On the monetary policy side again, as I said, and I will repeat that again. We do expect inflation to come down, and that's certainly something that people should benefit from in the foreseeable future.

And finally, maybe one more time, also on the investment measures to improve investment and the structural reforms in that area. Ultimately the aim of those is to create a constant steady stream of new jobs that meet the expectations and requirements of the population, and this private sector led growth and increasing incomes will come over time. And stabilization is already gaining a foothold, and we have seen positive trends including in investment, and we expect that to deepen and strengthen over time.

And confidence has improved and once that becomes entrenched, I think it will be clear, that benefits are accruing, and certainly, I mean, this is a very ambitious program, it takes time to work, but it is well calibrated and over the course of this economic program, of three years, we should definitely be seeing the payoff in the remainder part of their program.

MODERATOR: Okay, I think we have answered most of the questions. We will have a lot of material posted online. We ask you to check at 9:00.

I just want to repeat that this is embargoed until 9:00 a.m. Washington time, which is 3:00 p.m. Cairo time.

Thank you Subir, and we look forward to working with you again on this. Thank you.

MR. LALL: Thank you.

IMF Communications Department


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