In a curious development, Egypt started its Fund programme in 2016 just as Pakistan was successfully concluding its last programme (2013-16).
And now, as Pakistan has decided to seek the Fund’s assistance once more, Egypt successfully concluded its three-year programme a few weeks ago when it completed the fifth and final review at the staff level. It would be useful to see if there are any lessons from Egyptian experience that would help Pakistan successfully complete its new programme.
Pakistan and Egypt are very different economies in terms of their institutional structures and management styles. Apart from the political upheavals that Egypt has passed through, economic imbalances were building for a long time. The need for an IMF programme had been felt for at least five years before it was finally concluded in 2016. With comparable GDPs, Pakistan has twice the population of Egypt. Thus, Egyptians enjoy per capita income that is double that of Pakistan.
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Even though the nature of imbalances is similar, yet it is very different in the context of the political settings of the two countries. For instance, in Egypt food and fuel subsidies have existed for a long time and posed a severe burden on the budget; however, their rationalization carries huge political costs. Except for electricity subsidies, Pakistan does not face such fiscal burden. Similarly, the exchange rate was vastly over-valued: the official exchange rate was pegged at EGP8 (8 Egyptian pound) to a dollar for a long time, while it was nearly EGP19 in the curb market. Here again, Pakistan has long abandoned a pegged exchange rate though we had phases when the dollar was not adjusted as much as market forces would have warranted.
The other challenges included: falling reserves ($15 billion or less than three months of imports), high current account deficit (6 percent of GDP) distorted interest rates (negative real rates), rising fiscal deficit (10 percent or more), primarily due to high food and fuel subsidies (more than 5 percent of GDP), rising public debt (103 percent of GDP), slow economic growth (4 percent), rising inflation (15 percent) and unemployment (12 percent). In varying degrees, these are similar to those we faced in Pakistan in run-up to the new IMF programme.
Sporadic reform measures comprising exchange rate corrections, partial rationalization of food and fuel subsidies, introduction of Value Added Tax (VAT) (which was initially imposed but later withdrawn) and review of the wage bill were taken, but they were not enough as current account, budget deficit and shortage of foreign exchange continued to build up.
It was in this background that Egypt approached the IMF, which approved a three-year Extended Fund Facility (EFF) of $12 billion in November 2016. The prior actions were, to say the least, onerous. First, a massive devaluation (nearly 50 percent) of the local currency (Egyptian pound) and allowing free-float of the exchange rate with removal of all restrictions on the working of the foreign exchange market. Second, imposition of VAT after parliament approved the law. Third, a 300 bps (3 percent) increase in the interest rate of the central bank. Fourth, elimination or reduction of fuel and food subsidies. Fifth, elimination of government borrowings from the central bank. Sixth, design of a more targeted programme of social protection comprising rationalized subsidies also. The programme was to be monitored biannually in 5-6 reviews.
The decision of the regime of Abdel Fateh El-Sisi – the former army chief who overthrew the elected government of Mohamad Morsi in July 2013 – to go for an IMF programme was not an easy one. It spent considerable time to avoid this option. The friendly support he received from Saudi Arabia and UAE was considerable and helped delay the programme. The pains inherent in a Fund programme, particularly where imbalances are deeply imbedded in the working of the economy and people are used to subsidies in any shape – over-valued exchange rate (that induced excessive imports), low interest rates (excess demand for credit), low prices of fuels (creating excess demand) and food subsidies (leading to waste and pilferage) and high wages (not justified by efficiency) – would lead to political backlash.
But then a point comes when the imbalances are simply unmanageable. Typically, the external account becomes impossible as the hard currency to finance it is not forthcoming. It was at such a point that General Sisi asked people to endure and be patient. He assured them that after two years, his government would bring a positive change in their economic lives. He also promised to protect the poor from the inflation that would result from the programme. On the eve of the programme, the Supreme Investment Council, a newly-formed body led by Sisi, approved a package of measures designed to spur the economy, including a three-year freeze on taxing capital gains on stocks and an unspecified increase in the number of state-owned companies to be partially privatized.
The Egyptian polity has given considerable leverage to the president in implementing the IMF programme. All commitments under the programme were fulfilled without any signs of weakening resolve. However, as expected, the immediate effects of the programme were extremely painful. Even partial withdrawal of food and fuel subsidies meant the poor would be hurt the most. Inflation shot up to 40 percent in March 2017 as the brunt of adjustment fully materialized – VAT, devaluation, high interest rates and partial removal of subsidies. Mercifully, the subsidy on bread, with strict rationing per person, was preserved as rice became out of reach after massive devaluation, and poor families substituted bread for all meals.
The bread subsidy has painful memories. Back in 1977, on a similar occasion to secure loans from IMF and World Bank, the authorities scrapped food subsidies; bread riots spread across Egyptian cities. For this reason, the lenders stayed clear of demanding an end to the bread subsidy programme. The sensitivity around the programme is so intense that when the minister for supplies attempted to twist it in the name of checking abuses, protests broke out in several cities and the efforts had to be abandoned. The open market price of bread is 15 times higher and, therefore, there is a strong incentive to abuse the system.
To be continued
The writer is a former finance secretary. Email: email@example.com
(This news/article originally appeared in The News on July 10th, 2019)