Impact of Economic Reform Measures on Purchasing Power in Egypt

Impact of Economic Reform Measures on Purchasing Power in Egypt

Literature Review

By: Mohammad Mashaly

April 2018

Impact of Economic Reform Measures on Purchasing Power in Egypt

1. Literature Reviews

The economic reform in Egypt as independent variable had different measures and elements which effect on the purchasing power parity as a dependent variable in this research.

1. Economic Reform

The economic reform measures in Egypt since the revolution 2011 couldn’t be avoided due to the political instability which led to economic collapse, Ms. Christine Lagarde, IMF Managing Director and Chair (2016), said: “The Egyptian authorities have developed a homegrown economic program, which will be supported under the IMF’s Extended Fund Facility, to address longstanding challenges in the Egyptian economy”.

These include: a balance of payments problem manifested in an overvalued exchange rate, and foreign exchange shortages; large budget deficits that led to
rising public debt; and low growth with high unemployment. The authorities recognize that resolute implementation of the policy package under the economic program is essential to restore investor confidence, reduce inflation to single digits, rebuild international reserves, strengthen public finances, and encourage private sector-led growth.

1. Local Currency Floating

IMF (2016), The liberalization of the exchange rate regime and the devaluation of the Egyptian pound were critical steps toward restoring confidence in the economy and eliminating foreign exchange shortages. The new exchange rate regime will be supported by prudently tight monetary policy to anchor inflation expectations, contain domestic and external demand pressures, and allow accumulation of foreign exchange reserves.

1. Raising Interest Rates

IMF (2016), The authorities initiated policy adjustment measures in 2014/15. The Central Bank of Egypt (CBE) devalued the Egyptian pound by 5 percent and increased interest rates to contain inflationary pressures. Fuel and electricity prices were raised, and a plan for gradual phasing out of these subsidies was developed. As a result, the subsidy bill fell by nearly 3 percent of GDP in fiscal year (FY) 2014/15.

In addition, a new Civil Service law was drafted and a decision was taken to replace the General Sales Tax with VAT. In 2015/16, however, the momentum of reform slowed. Planned fuel price increases were deferred, income taxes were 3 cut, the capital gains tax was postponed and parliamentary consideration of VAT was delayed to 2016/17.

1. Reducing Subsidies

Humanitarian Foresight Think Tank (2017), The state’s subsidy regime predominantly subsidizes energy, followed by food. Before November reform, energy subsidies accounted for a full 21% of the country’s budget and 73% of the subsidy budget—61 billion pounds in the 2015/16 budget. Accounting for the biggest drain on GDP, the Egyptian government has targeted energy subsidies first.

Though the distribution of beneficiaries is skewed to the wealthiest 10% of Egyptians who own vehicles and air-conditioning units, the poor are also adversely impacted by the removal of these subsidies. Simulations conducted in 2009 on the removal of subsidies showed a negative GDP growth rate and worsening household welfare across social strata; yet the compounded impacts of inflation and unemployment assume that energy expenses will account for a greater proportion of household income for the poor, therefore mounting to a far greater impact. Since November, energy subsidies have been reduced by almost half, and will be culled further.

1. Unemployment Rate

IRIS (2017), Egypt’s battered economy is the focus of government efforts, as the structural reform project implemented in November 2016 continues with the further decrease in energy and food subsidies, energy sector investment and infrastructure construction. Unfortunately, a strategy aimed at strengthening the resilience of the state is not followed with concerted efforts to protect Egypt’s most vulnerable.

Despite an increase in some targeted assistance, the impact of high unemployment rates and depressed wages draws more Egyptians into poverty. This justifies the further expansion of the military into cheaper state service provision, through food production and sale, infrastructure development and health provision. However, the strengthening of the military’s role in these sectors does not lead to greater employment and competes with private sector businesses who contribute and participate in the economy.

1. Inflation Rate

IMF (2016), Growth slowed in 2015/16, while inflation increased and external vulnerabilities became more acute. The economy is estimated to have grown by 3.8 percent in 2015/16. Foreign exchange shortages and the overvalued currency hampered the manufacturing sector, while tourism was hard hit by security concerns. Inflationary pressures intensified in the second half of the year.

The current account deficit widened further, and in June 2016 reserves stood at about 3 months of prospective imports. The devaluation of the official exchange rate by 13 percent in March 2016 did not restore market equilibrium, and strong pressures on the exchange rate and reserves remained. By the end of September, the parallel market premium widened to more than 30 percent, and the official exchange rate was estimated to be overvalued by about 25 percent in real effective terms.