Fiscal Deficit On The Rise

Egypt's budget spending has increased sharply over the past two years as the government has made supplementary allocations to food and fuel subsidies so as to avoid passing on the full costs of the escalation in commodity prices to consumers. However, the government has managed to keep the deficit within the target range thanks to the strong revenue performance, which has arisen both from the robust rates of real GDP growth, averaging about 7%, and from improved tax collection.

According to final budget outturn figures issued by Mr Boutros-Ghali earlier this month, the fiscal deficit in 2007/08 was E£59bn, equivalent to 6.8% of GDP, compared with E£54.7bn and 7.5% of GDP the previous year. The primary deficit, excluding debt service payments was about 1% of GDP.

He said that total revenue rose by 21.2% year on year to E£218bn, with tax and customs revenue increasing by 20.2% to E£137.4bn and non-tax revenue (including Suez Canal dues, petroleum surpluses and proceeds of the sale of 3G telecoms licences) rising by 23.1% to E£81.1bn. Income tax rose by 15% to E£76bn, while sales tax proceeds increased by 30.9% to E£40bn. Customs revenue rose by one-third to E£14bn.

Total expenditure in 2007/08 increased by 25% to E£277 (32% of GDP) from E£222bn (30.4% of GDP) the previous year. Subsidies became the largest category of budget spending, rising 56% year on year to E£84.2bn. This sum included E£60.3bn for fuel and E£16.5bn for food. The public-sector wage bill went up by 19% to E£62bn.

Although the government has managed to keep the fiscal deficit under control, Egypt has the highest inflation rate in the Arab world. The most recent official figures show that consumer prices rose by 22.2% year on year in July. The tight monetary policy adopted by the Central Bank of Egypt (which hiked interest rates in August for the fifth time this year) and the stabilisation of commodity prices will probably bring the inflation rate down below 10% on average in 2009.

Egypt's Economy Grows At 7.2% In the Year To June

The Egyptian economy beat forecasts and grew at a 7.2 per cent in the fiscal year which ended in June. This was the fastest pace in at least two decades, although slowing private consumption indicates growth may well ease back in the second half of the year.

Since the Egyptian Government had previously stated that gross domestic product grew at an annualised rate of 7.4 per cent in the first nine months of the financial year, the whole year figure would seem to indicates that growth slowed to an annualised of around 6.6 per cent in the April-June quarter.

The Egyptian economy is battling rising inflation, which hit a 16-year high of 22 percent in the year to July. Inflation is expected to remain high until the end of the year before dropping in 2009.

Tourism Minister Zoheir Garrana said earlier this month that the number of people visiting Egypt increased more than 25 per cent in the fiscal year 2007/2008, while revenue increased 32 per cent.

The challenge is that the global economic environment is deteriorating, with all major economies (US, Eurozone, UK and Japan) slowing down. At the same time, on the domestic front, inflationary pressures seem to continue unabated: money supply growth as measured by M2 rose 15.45% y/y essentially unchanged from the June figure at 15.72%, according to Central Bank data released on Sunday. While this better than expected performance of the Egyptian economy is reassuring and the long term prospects of the country are positive, there will be cyclical headwinds facing Egypt in the short term, with the budget deficit, inflation and food prices being the main concerns.

Is Egypt Similar To Vietnam?

Citibank analyst David Lubin looks at the Egyptian economy and asks whether there is a risk that the Egyptian pound follows the Vietnamese Dong. He concludes the risk is slight, and I tend to agree. Here are his arguments.

There are some superficial similarities between the two countries: both governments have strongly pursued rapid GDP growth, and both have relied on rather inflexible exchange rates. Both have enjoyed large capital inflows in recent years, and the inflationary shock of the past few months has caused real interest rates to fall sharply into negative territory in both cases. Yet we think the decline in Egyptian real interest rates should be interpreted in a different way than makes sense for Vietnam, for two reasons. The first is that there is really no evidence of a credit boom in Egypt, and so a collapse in real interest rates runs little risk of generating a credit bubble in the short run. While the stock of Vietnamese private credit rose from 66% to 93% of GDP between 2005 and 2007, the stock of Egyptian credit actually declined from 51% to 46% over the same period! A second reason why low real interest rates in Egypt pose fewer risks than they do in Vietnam has to do with the balance of payments position. Vietnam’s very large current account deficit means that it needs to attract net capital inflows from abroad. The exchange rate risk that is normally associated with a large current account deficit requires positive inflation-adjusted returns for investors to feel compensated for that risk; Vietnam’s failure to do so likely created incentives for capital flight. Egypt’s balance of payments is much more robust than Vietnam’s.

The stability of Egypt’s nominal exchange rate is also underpinned, we think, by the strength of Egypt’s foreign exchange balance sheet. Vietnam is now a net debtor in foreign currencies to the international banking system, while Egypt is a substantial net creditor. At a broader level, too, Egypt’s net creditor status is secure: its total gross external debt is just over US$30 billion, while its foreign assets are some US$57 billion, of which central bank reserves make up around US$33 billion. Although we believe Egypt’s balance of payments is set to deteriorate, it would take some time for fundamentals to become as weak as Vietnam’s.

The pound’s weakness in recent weeks is thanks to the depreciation of EUR/US$. Even if the dollar strengthens substantially, we don’t believe that the Central Bank will offset such a move versus the euro with a like-for-like depreciation of the pound against the dollar. The reason we hold this view is that we think Egyptian inflationary expectations are more influenced by EGP/US$ than by EGP/EUR. Since the Central Bank of Egypt (CBE) has to worry as much about inflation as about competitiveness, we think it will tread a middle path. Our forecasts suggest a return to 5.3 for EGP/US$ this year, and a period of stability at that level. Citi’s expectation that EUR/US$ will weaken towards 1.25 next year means that our EGP/US$ forecast implies some appreciation of Egypt’s nominal trade-weighted exchange rate. We think this appreciation is modest and consistent with the CBE’s aim to control inflation.