IMF signs off on Egypt’s non-compliance with loan program, sets new policy pledges

After more than a year of stalled reviews of Egypt’s December 2022 loan, the International Monetary Fund published a report over the weekend documenting the progress on the program's policy prescriptions.

The report, based on the IMF’s March review, outlines what was already clear for many: Egypt had failed to make much progress on its policy commitments, with the IMF saying that eight of 15 pledges had not been met.

In its report, the IMF notes that it has received and approved a waiver of non-compliance from Egypt for the policies mandated under the 2022 US$3 billion loan agreement. This approval cleared the way for the disbursal of US$820 million to Egypt earlier this month, only the second disbursal since December 2022.

Despite the non-compliance, Egypt and the fund formally agreed to augment the value of the loan from $3 billion to $8 billion on March 30.

While the IMF was forgiving for the failure to make progress, the report outlines a series of renewed pledges that Egypt must adhere to in forthcoming reviews, specifically addressing spending on national projects, containing fuel subsidies and creating a competitive climate for the private sector. 

Many of these new policy prescriptions come as measures to address past non-compliance.  

The first policy mandate has already been ticked off, according to the report. Egyptian authorities unified the formal and informal exchange rates which had steadily widened over 2023, eventually peaking at over LE70 per dollar on the black market while the Central Bank of Egypt had the official rate pegged at LE31.

Egypt had long made its stance clear on adjusting the official rate of the pound. In a nationally televised speech in June last year, President Abdel Fattah al-Sisi declared the call for a flexible exchange rate a threat to national security. Economic experts explained to Mada Masr that a devaluation without having secured dollar inflows could set off a vicious devaluation spiral. By January of this year, sources familiar with the loan negotiations told Mada Masr that the IMF and Egypt agreed on a loan value increase but that final approval was subject to the actual implementation of a currency devaluation. 

Things finally aligned when Egypt and the United Arab Emirates inked a US$24 billion investment deal in late February. Less than two weeks later, the central bank allowed the pound’s official value to drop by nearly 60 percent, from LE31 to LE49.56. The floatation was paired with a historic hike in interest rates to try to tighten the monetary supply.

In its waiver of non-compliance to the lending authority, the Egyptian government stressed the deal’s importance in terms of reducing external and fiscal vulnerabilities, vowing that half of the investments will be used by Egypt to service its debts.

Alleviating debt burdens was another move required by the IMF. The financial agency stated in its report that the Finance Ministry committed to allocating an amount equivalent to US$12 billion in local currency from the Ras al-Hikma deal to debt servicing, which would translate into an increase of the government’s primary balance — its net borrowing or lending, excluding interest expenditures — by 4.6 percent of the GDP and a reduction in debt of the same value.

The IMF also addressed other budgetary lines in the report, noting that over the course of 2023, Egypt continued to apply an amount of energy subsidies out of keeping with its budgetary capacities. The government has been paying billions of pounds in subsidies for months to keep consumer prices fixed amid skyrocketing inflation.

In the new policy prescriptions, the IMF is asking Egypt to rein in “unaffordable energy subsidies” and fuel prices in accordance with the prices mandated by the automatic fuel pricing committee and redirect expenses to social support for the vulnerable.

Due to past inaction, fuel prices need to be increased, the report says, adding that “authorities will also develop a plan to adjust diesel prices to be fully in line with the level implied by the full implementation of the formula since the start of the program.”

The removal of subsidies will, however, have a considerate impact on inflation rates. Mostafa Shafei, a macroeconomic analyst at Arabeya Online, previously told Mada Masr that the state was retreating from its previous approach to managing energy prices, which had been to avoid raising diesel prices in particular, because of their direct and significant inflationary effect, namely on agricultural production and transportation costs.

“The IMF imposes the same way of thinking that was previously applied, such as giving priority to adjusting monetary policy. It talks about inflation, but, in reality, all the policies result in an inflationary shock, such as when they call for exchange rate flexibility. Flexibility is usually an up-and-down process. But in Egypt’s case, a flexible exchange rate is always tied to a devaluation of the pound, and it always causes, given our situation as an import country, an increase in prices,” economist Wael Gamal tells Mada Masr.

To address inflationary pressures on vulnerable households over the past years, Egypt adhered to the lending authority’s proscription to strengthen social protection, bringing the number of households benefiting from the Takaful and Karama program to 5 million.

A LE180 million social protection package was also approved by Sisi in February, increasing wages and pensions for public sector employees, among other reforms.

But the report doesn’t look at its own austerity mandate as the cause of inflation. Instead, it points to “continued investment in national projects at a pace inconsistent with macroeconomic stability,” proposing new targets for government guarantees and public investment, including spending on national projects.

Public investment on mega projects in fiscal year 2021/2022 was valued at LE225 billion, with the achieved amount valued at LE197 billion, while in FY 2022/2023, spending rose to LE237 billion with an outturn of LE93 billion, according to the financial agency’s calculations based on data obtained from the planning and finance ministries.

Egypt pledged to slow down projects included in the state budget, including national projects less than 70 percent complete. Funding for state budget investment in the second half of FY 2023/24 was also cut by 15 percent compared to the previous year, and new projects were postponed. 

Even though the decision will only apply to the final four months of the current fiscal year, “it might tone down pressures on the state budget in order to achieve gross domestic product growth,” head of research at Arabeya Online Brokerage Mostafa Shafie previously told Mada Masr, adding that it could theoretically be extended to FY 2024/25 as well.

“People in Egypt could ask us why we spend so much, but do we have another choice? Either we become like other human beings around the world, or we stay underdeveloped,” Sisi said, commenting on rising criticism of national projects amid economic struggles during the inauguration of the Government Data and Cloud Computing Center on Sunday.

Meanwhile, the Egyptian government stated its commitment to better control public sector expenditures and its intention to issue a prime ministerial decree requiring “all public entities to report annual projected and executed investment spending, including projects contracted or undertaken by entities such as the Administrative Capital Urban Development (ACUD) and the Armed Forces Engineering Authority and its affiliates, to a cabinet-level committee chaired by the Central Auditing Organization (CAO).”

Besides curbing public investment, the government further attempted to set the climate for private sector investors by putting an end to tax exemptions for all state-owned companies in July 2023, with some notable vagueness around the Armed Forces’ entities. It fell short, however, of issuing an annual report on tax expenses that the IMF requested in 2022 to include details on state entities exempted from such obligations.

However, Egypt still managed to achieve several other loan proscriptions, including the development and issuance of a state ownership policy in 2023, a measure required for transparency that was on hold since the loan agreement was signed in 2022.

The amendment of the competition law was also commended by the IMF, which said it would allow for an improved business climate. The law’s amendment aimed to give the Egyptian Competition Authority more independence in combating monopolistic practices.

The state’s progress in its privatization program was also applauded by the financing institution, as, after a year of slowly developing asset sales, $2.4 billion in net revenues were acquired from the IPOs in addition to $2.2 billion in dollar inflows during fiscal year 2023/24. Egypt will pursue a sector-by-sector approach to divestment, the report added, predicting another US$600 to US$700 million from further asset sales in the current fiscal year.

“These measures [new policy proscriptions] will be supported by expanded conditionality, which would also serve to improve public transparency around such operations,” said the report, adding that the government eliminated preferential tax treatments and exemptions for state-owned enterprises as well as developed an indicator to monitor the state ownership policy’s implementation.

The IMF plans to monitor the transparency of the state ownership policy’s implementation, said the report, paired with an annual report on the policy’s activity, which Egypt will be responsible for, given its critical importance in achieving the loan program’s target of equal opportunity for the private sector.

While the augmented loan gives Egypt a fresh start in its relationship with the IMF, the funding organization’s “risks are elevated, and capacity to repay the fund is subject to high risks and contingent on full program implementation and the materialization of all projected financing.” 

According to the lending authority, risks are imminent if Egypt fails to maintain the shift to a liberalized exchange rate system and a monetary policy that prevents inflation from decreasing, and if it fails to deliver transparent integration of off-budget investments into macroeconomic decisions. 

But Gamal sees that the austerity measures required by the IMF will have a countereffect. He explains that the fund’s recommendation to achieve income or revenue-exceeding expenditures (primary surplus), which the government set at 3.5 percent of the GDP in the FY 2024/25 draft budget, translates into toning down spending and increasing taxes, which, he explains, always hinders economic activity. “So they are saying they want to do something, but the policies they require do the exact opposite.”

Growth rates are negatively impacted by three factors: price increases, interest rate hikes and reduced public spending, Gamal explains, which are all phenomena Egypt is currently facing and “could lead to economic depression, or at least restrict purchasing power.”

Consumption is one of Egypt’s primary growth rate engines, therefore, when prices hike, people’s purchasing power falls and they buy less. On the business level, high interest rates mean businesses are less likely to take loans from banks given the high cost of borrowing and debt servicing. On the governmental level, reducing public expenditures slows down growth prospects.

“They did not change this doctrine and are still talking about interest rate hikes as a measure to combat inflation, which does not happen. They talk about devaluation as a way to increase exports, which never happened in Egypt or in the past 10 years, during which the pound’s value decreased several times,” Gamal added.

Egypt is required to pay $32.79 billion in debt obligations during 2024, with total external debt reaching $164 billion in January.

For the IMF, nearly $6.11 billion is due for the current year. Then, the government will continue to repay loan installments, interest and administrative fees for the four IMF loans it has agreed to over the last decade until 2037.

Finance Minister Mohamed Miaet said last month that the ministry aims to decrease the debt-to-GDP ratio to 80 percent in the next three years.

According to Gamal, high debt obligations and their high interest rates increase Egypt's vulnerability, even to external shocks, such as the wars in Ukraine and Gaza and mounting Red Sea tensions affecting Suez Canal revenues — risks that the report said could intensify macroeconomic challenges.

“We took a painkiller, but there are many measures that need to be applied to avoid the crisis,” Gamal says. “But they don’t seem to be on the agenda.”