The announcement on August 15 that International Monetary Fund (IMF) Managing Director Christine Lagarde will visit Cairo on August 22 has created considerable speculation that an IMF program will be implemented soon. While it could be merely a courtesy visit—Lagarde was after all invited by the government of Egypt and could hardly refuse without sending unnecessary negative signals to the international community and the markets—the fact that an IMF team was expected to be in Cairo at the end of August to start formal negotiations suggests something more substantive. The Egyptians can also take advantage of Lagarde’s visit to make the case directly to her for a loan significantly larger than the $3.2 billion number that has been widely reported.
The visit by Lagarde at the beginning of the negotiations says two things: first, that the IMF is sufficiently optimistic about negotiating a program that the Managing Director is willing to be seen out front; and second, that Egypt is a sufficiently important country that it warrants close attention by the top management of the IMF. Therefore, Lagarde’s visit can be viewed as sending a signal to the Egyptian public about the seriousness of the IMF’s intentions to negotiate an acceptable program, as well as a signal to the international community and the markets that the IMF is ready to support Egypt financially and endorse its supposedly “homegrown” economic program.
Assuming that an IMF program is finally in the cards (after some premature announcements over the last couple of months by Finance Minister Momtaz El-Said that an agreement was close at hand), what should the IMF and the Egyptian government be looking for in it? Clearly the economic picture in Egypt has steadily worsened since the fall of the Hosni Mubarak regime in February 2011. Virtually all macroeconomic indicators—growth, employment, the external current account balance, foreign direct investment, the fiscal position—point to an economy in considerable distress. With international reserves reaching a low of $14 billion, down from over $36 billion at the end of 2010, and absent any large scale external financing, a currency crisis is in the making. Some funding has come from Saudi Arabia ($1 billion) and some is expected shortly from Qatar ($2 billion) and Libya ($2 billion). But the external financing gap is more than $20 billion if a buildup in international reserves by $5 billion to $6 billion is factored in. Thus, Egypt needs much more external financing, and many donors and investors are understandably waiting on the sidelines for a clear signal that Egypt’s new government has got its economic act together.
An IMF program would provide Egyptians and the international community evidence that the Egyptian government is in the process of putting its economic house in order. An IMF program would bring clear macroeconomic discipline into the picture. In June 2011, the IMF and the interim Egyptian government were close to reaching an agreement on a Stand-by Arrangement (SBA) amounting of $3.2 billion (or 200 percent of Egypt’s IMF quota). The agreement outlined the policies required to achieve macroeconomic stability and the economic reforms that would generate higher growth and employment. The loan, as customary for the IMF, was to be disbursed in tranches conditional on the implementation of the policies and structural reforms. The conditionality, however, was considered by most observers to be relatively light.
In a new program with Egypt, the IMF should give the highest priority to two issues. First, rationalizing the very costly subsidies scheme in existence in Egypt. In the current FY 2012–13 budget, food and energy subsidies amount to 27 percent of total expenditures (and more than 10 percent of GDP). Replacing the subsidies scheme with a more targeted system directed at the truly needy, possibly through direct cash transfers or coupons, is essential to ensuring long term fiscal sustainability. Second, the Central Bank of Egypt (CBE) has to let the exchange rate move in response to market pressures. The cost of keeping the Egyptian pound relatively stable since the beginning of 2011 has resulted in a loss of more than $20 billion of foreign exchange reserves. The IMF has to insist on this condition and press the CBE to allow the currency to depreciate in a managed way. While a sharp devaluation might well be destabilizing, and there might be a need for continued intervention by the CBE in the foreign exchange market, leaving the rate unchanged is only asking for trouble down the road.
What is in it for Egypt? Certainly an IMF program that endorses the Egyptian government’s economic plan will go a long way towards persuading foreign investors to return to Egypt and convincing donors to provide the financing they promised. It will also send a positive message to domestic businessmen and investors that the government is serious about delivering on its commitments to macroeconomic stability and job creation. And finally, the IMF loan will itself help fill the financing gap and at a very low interest rate of 1.2 percent. In contrast, the Egyptian government is presently paying 16 percent on its domestic borrowing. Last year the discussion between Egypt and the IMF was for a loan of $3.2 billion, a figure that has been repeated since. But at that time international reserves were more than $26 billion, which is more than $11 billion above their current levels. Given the worsened economic situation, and drawing on the experience of the recent IMF program with Jordan, where the country received 800 percent of its IMF quota, the Egyptians should ask the IMF for a substantially higher amount of funding. Minister Momtaz El-Said has already mentioned a figure of $4.8 billion (300 percent of quota), but there is no reason why the loan could not be as much as $8 billion, or even larger. Additional financing of this amount would partly fill the financing gap and also allow Egypt to build up its international reserves—an indicator that ranks very high in the minds of foreign investors—to a safer level.
The Lagarde visit, especially if it is followed soon by an agreement between Egypt and the IMF, could well prove to be a turning point in Egypt’s economic fortunes.
Mohsin Khan is a senior fellow with the Rafik Hariri Center for the Middle East at the Atlantic Council as well as a senior fellow at the Peterson Institute for International Economics. This article was also posted on the Atlantic Council website.