Egypt's economy in a vulnerable context: Is it the Russia-Ukraine war or wrong economic policies

In its special meeting yesterday, the Monetary Policy Committee (MPC) raised the overnight deposit rate, the overnight lending rate and the rate of the main operation by 100 basis points to 9.25%, 10.25%, and 9.75%, respectively. The discount rate was also raised by 100 basis points to 9.75%. 

In its statement, the Committee explained the decision, saying that growing inflationary pressure due to COVID-19 pandemic has affected the whole world. There was a little improvement in the world economy recently. However, according to the Egyptian MPC, ''Russia-Ukraine conflict'' was an additional blow. Therefore, the Central Bank of Egypt (CBE) decided to adopt a more flexible exchange rate to act as a shock absorber to preserve Egypt’s competitiveness as well as to safeguard the achieved macroeconomic stability.

In light of the above, the exchange rate of the US dollar jumped from 15.73 Egyptian Pound (EGP) to 18.26 EGP, while two of the largest state lender banks in Egypt offered certificates of deposit with an 18% annual yield, National Bank of Egypt and Bank Misr. That means Egypt will experience an increase of the inflation rates. The German economist, Karl Otto Pohl described the inflation as, “It is like toothpaste. Once it is out, you can hardly get it back in again. The best thing is not to squeeze too hard on the tube”.

Egypt’s Pound drops a steep 22% against the US Dollar, making life for Egyptians ever more expensive as imports prices spiral in addition to inflationary pressures on all locally produced goods and services. How will it affect the average family?

To shed light on what is expected to happen, we need to start with basics first. Economists define ''inflation'' simply as “when the prices for just about everything go up at the same time”. The increase of inflation rates affect people’s lives badly. The first known effect is eroding purchasing power. Money is no longer has the same value, which consequently affect people's ability to secure their needs. Moreover, people start to stock up on things that probably will not lose value, such as gold, real estate, etc. The increase of inflation rate also raises the cost of borrowing. Countries try their best to keep price rises in check. However, in this situation it means that they need to use monetary policy in order to do so. Central banks relies on the relationship between inflation and interest rates. Low interest rate encourage spending and investing, which generally stokes inflation in turn; instead, high interest rate means that public money will be put in banks. Like the two largest state lender banks in Egypt offered certificates with an 18% annual yield, which will encourage the public to put their money in these two banks. However, this high interest rate directs money away from investments, which in turn would cause weak economic growth and increases unemployment rates. Inflation negatively affects government revenue and expenditure as well; as a consequence, it generally increases the size of the fiscal deficit. High inflation rates also increase the costs of domestic public debt and external debt, where the external debt represents the debt owed to lenders outside the country and internal debt represents the government's obligations to domestic lenders.

According to CBE, Egypt's external debt increased by about $14.4 billion to $137.9 billion in June 2021, compared to $123.5 billion in June 2020. This increase was a normal result of the rise in net disbursements of loans and facilities by $12.2 billion. However, after the huge rise in the exchange rate of US dollar to 18.26 EGP, this is dramatically expected to increase. In 2020, the national public debt of Egypt (domestic debt) amounted to around $334.09 bn, has increased $48.81 bn since 2019. This amount is expected to reach $399.72 bn in 2022.

The reasons behind the increase of the inflation rate varies between political and economic reason. According to a very recent study in 2022, a higher inflation is associated with ''greater political instability, and less democratic political systems''. The political authority pattern adopted by the country, itself, is a determinant of inflation. A more democratic authority pattern generally associated with lower inflation. Meanwhile, democratic political policies help in changing the economic and are considered another channel in which political reform would support the control of inflation.

The economic reasons could be a wrong economic policies, or global situation among other things. No one can deny that Russia-Ukraine war has negatively impacted the situation in Egypt. On one hand, Egypt, the largest importer of wheat globally, imports 60.4% of its wheat from Russia, 25.6% of its wheat from Ukraine, while the final 14% from other countries. Egypt's tourism sector as well is expecting a painful blow, with almost a third of the country's tourists coming from either Russia or Ukraine. Russia’s invasion of Ukraine has definitely pushed up inflation to a higher level in Egypt. However, the allegation that it is the only reason behind the increase of the Egyptian inflation rate is questionable.

The wrong economic policies that have been adopted by the government exacerbate the problem further. The national fiscal budget for the year 2021/2022 was approved for 2.46 trillion EGP ($158 bn). The priorities in this budget were for the net disbursements of loans and facilities; the new capital city development, and government officials budgets, while  the budget for health and education sectors were both less than half of what the constitution states.

Egypt’s budget for the year 2021/2022 was approved for $158 bn. The priorities were for the servicing loans; the new capital city development, and government officials budgets, while  the health and education sectors received less than half of what the constitution states.

Egypt’s President stated last month that the cost of infrastructure projects in Egypt worth $400 billion within only seven years, infrastructure projects could significantly be important to attract investments. In Egypt, the main infrastructure projects are concerned with transport. Transport alone remains the single-largest recipient of infrastructure investment, such as roads, bridges, tunnels, and monorail. This is followed by construction projects, such as new capital city.

Overall, theoretically speaking, infrastructure spending could have a stimulatory effect on Gross Domestic Product that is larger than some other types of spending because it attracts investments. Usually these projects are much important for industrial sector to connect chain of production. However, the Egyptian government investment in this sector is almost negligible for this year. As of the fiscal year 2021/2022, the government investment in Egypt was close to 358 bn EGP, investments in construction and real estate alone were estimated at 71.2% of the budget.

Infrastructure projects are useful when these projects address clear public needs that generate socioeconomic tangible quantifiable benefits. Furthermore, infrastructure provides social and economic advantages only when the generated revenues of a project can sustainably finance its capital and operating costs. Too many projects will become an economic burden and drain on finances when a government borrows money for an undertaking and neither its revenues nor its direct and indirect economic benefits adequately cover the cost.

Unfortunately, the Egyptian government is not executing the right projects with the most impact. It does not engage the community stakeholders to promote inclusive economic and social benefits. Not to mention, there is no coordination of infrastructure investments to account for their effects at all. These projects only serve a small group of wealthy Egyptians, if they do.

In the same context, the Egyptian military’s involvement in the economy has come at a high cost. This involvement contributes to underperformance in development. The construction of many of the projects mentioned previously are supervised directly by the Egyptian military or subcontractors that are provided by them. The military is also involved in production of goods, providing services. The new capital city is constructed by a firm that the military owns 51% of. Another military-owned company is building Egypt’s biggest cement plant. Many other projects, such as fish farms, holiday resorts, factories, etc, are directly owned or managed by the military. 

The Ministry of Military Production, one of three main bodies that oversee military firms, shows at its announced figures that revenues at its firms are rising sharply. These figures give rare insight into the way the military is growing in economic influence. However, this has a very negative impact on the whole society. The people cannot compete with such influence, especially that the military enjoys many benefits, which are not provided for small investors. The owners of small and medium-scale industry sector projects and private construction firms are on the losing end here. In 2017, the International Monetary Fund warned that Egypt's private sector really facing a trouble in developing and job creating because as it was mentioned, “Hindered by involvement of entities under the Ministry of Defence.”

An urgent revision of Egypt’s economic policies is a must. This revision must look to the long term to answer major challenges. Clear goals and innovative policies must be considered, while their outcomes must be measurable.

An urgent revision of Egypt’s economic policies is a must. This revision must look to the long term to answer major challenges. Clear goals and innovative policies must be considered, while their outcomes must be measurable. The support to the industry sector, especially small and medium-scale industry projects, tourism, trade, exporting, and any sector that could be a source of foreign currency. The government should only focus on one thing right now is to increase the economic growth via real projects that can improve the production, consequently the overall GDP.