Published March 05, 2013
CAIRO – Egypt is at risk of a "revolution of the hungry" two years after Hosni Mubarak was ousted in a popular uprising, as food and energy prices will soar with or without an IMF deal.
Failure to get the $4.8 billion loan or some other funding would have dire consequences: if Egypt keeps burning foreign currency at the rate it has done since the 2011 uprising, it will have none left in little more than a year.
But success would also stir Egypt's boiling social and political cauldron. In return for a lifeline, the International Monetary Fund will demand reform of a subsidy system that long ago became unaffordable.
The rich benefit most from the energy subsidies that exhaust state finances but the poor will suffer most if they go.
"Whether we have the IMF or not there will be difficulty ... the IMF requires certain economic reforms," said Salah Gouda, an economics professor. "If we lift subsidies right away then you are looking at a revolution of the hungry."
The economic gloom has dragged Egyptians from the high of the "Arab Spring" revolution to deepening poverty.
Constant feuding between the ruling Islamists of President Mohamed Mursi and the opposition over the future character of Egypt has heightened tensions and cast serious doubt on any hopes for a political consensus on reforming the economy.
The United States, the largest shareholder in the IMF, is worried about how the economic crisis could further destabilize a strategic ally in a turbulent region.
"It is paramount, essential, urgent that the Egyptian economy gets stronger, that it gets back on its feet," Secretary of State John Kerry said on a weekend visit to Cairo. "It's clear to us that the IMF arrangement needs to be reached, that we need to give the market that confidence."
The figures speak for themselves. The foreign currency reserves have slid to $13.5 billion at the end of February from $36 billion on the eve of the uprising.
The dive slowed sharply last month. However, reserves have fallen roughly $865 million a month since the end of 2010, meaning the current levels would last only about 15 months if this rate were to continue unabated.
"Egypt's foreign exchange reserves are still extremely low and below what the central bank previously called a critical minimum level," said William Jackson of Capital Economics in London. "Our bigger concern is if there is a fresh eruption in political turmoil, and investors and Egyptians lose confidence."
If Egypt were to run out of money - both foreign and local currency - the subsidy system would probably collapse anyway, leading to shortages and price rises in a chaotic return to the free market. Such a scenario of upheaval in the Arab world's most populous country supports those who say an IMF deal is vital.
Confidence is already in short supply. The central bank has spent more than $20 billion trying to prop up the Egyptian pound but it has still lost 14 percent against the dollar since before the revolution - more than half of this since the end of last year.
This slide has added to the huge burden on the budget from the subsidy system which dates back to the rule of nationalist President Gamal Abdel Nasser who seized power in 1952.
Its cost has been soaring for years along with the population, most of whom are squeezed into the five percent of Egyptian territory that is not desert.
Now the government is having to buy most of the oil and much of the wheat for subsidized energy and bread on international markets with a devaluing local currency. Subsidized bread, which goes to the poor as better-off Egyptians prefer higher quality loaves, consumes about five percent of the state budget.
A far bigger problem is energy, which devours about 20 percent of the budget. Petroleum Minister Osama Kamal estimated last month that the energy subsidy bill would hit 120 billion Egyptian pounds ($17.8 billion) in the financial year to June.
Egypt cannot afford this kind of money. In an economic plan produced last month for the IMF, the government forecast the budget deficit would reach 189.7 billion pounds this financial year. That would equal 10.9 percent of Egypt's total annual economic output and assumes that reforms will go ahead.
Without such action, the deficit would reach 12.3 percent of GDP. By contrast Portugal, a country where living standards are at least three times those of Egypt, had to seek a bailout from the IMF and European Union in 2011 even though its deficit peaked below 10 percent.
Inevitably the IMF will be gunning for the subsidies in negotiations for the loan, which have yet to start.
Masood Ahmed, who heads the IMF's Middle East and Central Asia Department, says that blanket subsidies are an inefficient way of protecting the weakest in society.
In an article looking at the Arab countries in general, he said that only about 20 to 35 percent of spending on subsidies reaches the poorest 40 percent of the population.
"Now that budgetary pressures make it all the more urgent to reform generalized subsidies, it has become equally urgent to develop better and more robust safety nets that target the needy," he wrote in this month's edition of the IMF's online Finance and Development magazine.
Two fifths of Egyptians live on less than $2 a day and while the poor don't own cars a big rise in fuel costs due to subsidy cuts would feed through to higher transport costs which would push up the price of the food they buy.
"When prices go up, there will be protests on the street as no one can afford the rising costs of living. The poor will suffer the most," said Gouda, who works at Beni Suef University in the Nile Delta.
Research by the African Development Bank backs him up. "Energy subsidies are often intended to support the poor but in practice benefit the rich," Vincent Castel, a program coordinator at the bank, wrote in an article on Egypt.
"Although the welfare loss is imposed on the entire population the poor and near-poor are most vulnerable because energy expenses account for a larger portion of their income."
Already tension is high across much of Egypt. Violence erupted in November and December after Mursi temporarily gave himself sweeping powers. This has subsided but around 60 were killed in the Suez Canal city of Port Said in January and unrest flared there again this week.
Such an explosive atmosphere will not make reform easy.
"In my view, there will be massive popular protests should these austerity measures be implemented," said Salwa Al-Antary, former head of research in Egypt's National Bank who now heads the economic committee in the Egyptian Socialist Party.
"Egyptians will feel squeezed with the rise in prices after having hope of improvement with the revolution."
Removal of subsidies would have startling results. Petroleum Minister Kamal has promised that subsidized fuel would remain available for some Egyptians under a rationing system. This is due to start in July but few details have yet been announced.
Costs outside this scheme would jump. According to projections compiled for the IMF, the commonly used 90 octane gasoline would leap to 5.71 Egyptian pounds ($0.85) a liter from 1.75, and diesel would go up to 5.21 pounds from 1.10.
Such increases would probably be phased in gradually but that risks prolonging any angry public response.
The IMF says reform cannot be sacrificed merely for the sake of stability in the Arab countries. "Important as it is now to focus on maintaining economic stability, it is vital not to lose sight of the more fundamental medium-term challenge of modernizing and diversifying the region's economies, creating more jobs, and providing fair and equitable opportunities for all," wrote Ahmed, who met Mursi in January.
However, reform remains the art of the possible. "In a second-best world, it may be necessary to move ahead with reforms that garner sufficient support and postpone others: some progress is better than none at all," Ahmed wrote.
He said the onus is on politicians to explain why the pain is needed and that money saved on wasteful spending can be redirected to items such as health and education.
"Policymakers should explain how expensive and inefficient existing subsidies are and the costs they impose on other parts of the budget," he wrote.
"In any reform involving revenue increases or expenditure cuts, it is important to demonstrate that the proceeds are being used to good effect."
On his visit to Cairo, Kerry stressed the need for Egyptian politicians across the spectrum to back reform. But the chances of that seem slim. Most of the liberal and leftist opposition parties have announced they will boycott parliamentary elections that start in April.
Any IMF deal should open the door to other help, such as from the World Bank, African Development Bank, Gulf Arab countries and the EU. However, many Egyptians doubt a deal would draw vital private sector investment in its wake.
"The IMF loan will not solve anything," said Gouda. "There is no security in the country and no one will want to invest in Egypt when there is political turmoil. With the IMF, Egypt would still need to beg for money." ($1 = 6.7421 Egyptian pounds)
(Additional reporting by Asma Alsharif; editing by Anna Willard)