Egypt’s Economic Challenges

Reporting on Egypt since the July 3 ouster of former president Mohamed Morsi has focused on political dimensions and unrest. However, it is the new government’s success—or lack thereof—in meeting the country’s economic challenges that will largely determine whether Egypt returns to stability, just as surely as it was Egypt’s economic woes that underpinned the country’s repudiation of Morsi. Egypt’s secular elite may have been provoked by Morsi’s supposed Islamicization of the constitution and efforts to centralize power in his hands, but what galvanized the masses to join in was a steady stream of bad economic news, including rising unemployment, shortages of electricity and gasoline, and an inability to obtain foreign exchange. If the new government cannot show progress on those fronts, the masses will turn on it as well; the clock is ticking.

In September, the government announced a $3.5 billion economic stimulus plan focused on labor-intensive investments, but that plan foresees only an increase in GDP growth from 2 percent in FY 2012/2013 to 3.5 percent in FY 2013/2014—well below Egypt’s needs for employment creation. Moreover, the plan is funded almost entirely by largesse from the Gulf Arab states. Additional domestic actions must take place against the backdrop of a still-daunting budget deficit that will constrain the government’s room to maneuver.

The Egyptian government must focus on four key issues in order to get its economy moving again.

• Reestablishing security: The first economic challenge is a political one. The government and the economy cannot function when protests strangle the capital. The government’s brutal crackdown on Muslim Brotherhood protests has cleared the streets of Cairo for now, but the record of the past two years has shown that they can resume at any time.   The government must learn to control future protests without resorting to deadly force, which further enflames the situation. Moreover, the return of foreign investment and foreign tourism will depend on the government’s success in keeping the peace. Tourism is Egypt’s largest foreign exchange earner and a major employment generator. The major tourism centers—the Sinai Peninsula, Cairo, and Upper (southern) Egypt have been among the areas worst hit by political violence in recent months.  The rise of extremist groups in the Sinai is the most worrisome.  The groups are confined mostly to areas away from the beach resorts, but that may change.  Fatal Islamist terrorist attacks on tourists in the 1980s and 1990s badly damaged the Egyptian economy and could do so again. The Mubarak regime fought a little-known but bloody war in the 1980s and 1990s with Islamists in Upper Egypt, which left the region behind the rest of the country economically. The new government must find a way to pacify and reconcile Islamists without an armed conflict; otherwise it risks repeating the situation in Upper Egypt, but writ large.   

• Bringing back exiled Egyptian business elites: Many of the leading Egyptian businessmen from the Mubarak era remain out of the country because of real or imagined fears that they may be prosecuted for alleged wrongdoing. While some businessmen were corrupt, many of those now overseas were honest and capable. Capital flight has been a persistent feature of Egypt over the past two years, and the country needs these elites’ skills and dollars. Foreign investors also are likely to view Egypt’s attitude toward these businessmen as a bellwether for its attitude toward foreign investment and the private sector in general. The military, long a major player in the Egyptian commercial sector, lost ground to private businessmen in the last few years of Mubarak’s rule. Welcoming back business elites would allay concerns that the military wants to resume a major commercial role. Bringing back elites might also have an important positive impact on remittances from Egyptians abroad, traditionally a strong factor in the economy that has also dried up over the past two years. From 2006-2010, Egypt averaged almost $6 billion in net foreign direct investment (FDI) inflows annually, but FDI inflows have almost disappeared since then. A resumption of strong investment flows is crucial to long-term economic growth and employment generation.  Welcoming back the elites would send a signal to both Egyptians abroad and foreign investors that their money is safe in Egypt.  

• Reforming subsidies: The still enormous list of Egyptian subsidies, particularly for energy (6 percent of GDP), is unsustainable in the long term. Prices for gasoline, propane (the main cooking fuel), and other fuels need to become more market-based. This will be universally unpopular, and so must be phased in slowly, but the system eventually must allow for more rapid adjustment of retail prices to world oil prices and exchange rate movements. This would reduce the budget deficit and free up funding for more critical needs. Safety net mechanisms should be developed that will allow price breaks for the poorest of the poor. Of course, movement on subsidy reform is also important to reach an agreement with the IMF (something Morsi was unable to do), and in turn would give another positive signal to investors.

• Labor-intensive industries and exports: Aside from tourism, Egypt’s traditional foreign exchange earners—oil and gas, Suez Canal fees, and remittances—are not major employment generators. The economic stimulus mentioned above is a start, but Egypt can and must do more to encourage investment in and export of labor-intensive goods such as clothing and horticulture products. Chinese labor costs are rising and Western importers have concerns about worker safety in Bangladesh, so an effort to expand Egyptian clothing exports might find a ready market. For example, Egypt could take advantage of the duty-free access to the U.S. market for goods produced in its Qualifying Industrial Zones (QIZs). QIZs can export goods to the United States duty free as long as they contain a minimum level of Israeli content. Former U.S. Trade Representative Ron Kirk announced in March a liberalization of the rules governing the Egyptian QIZs. Egypt has made limited use of QIZs in the past, for reasons that may have included the perceived or actual disapproval of Egyptian security and intelligence forces. However, the recent cooperation between Egyptian and Israeli security forces over the unrest in Sinai may foreshadow more openness to commercial cooperation as well.